Strategic alliances in Mexico : effects on the value of the firms

195
INSTITUTO TECNOLÓGICO Y DE ESTUDIOS SUPERIORES DE MONTERREY in collaboration with I. T. E. S. 1\L . (:, c. :\f. nrnT.T()TF.CA COLtCCION Dt NEGOCIOS Y ALTA úl?.[CCION THE COLLEGE AND GRADUATE SCHOOL OF BUSINESS THE UNIVERSITY OF TEXAS AT AUSTIN February, 1997

Transcript of Strategic alliances in Mexico : effects on the value of the firms

INSTITUTO TECNOLÓGICO Y DE ESTUDIOS SUPERIORES DE MONTERREY

in collaboration with

I. T. E. S. 1\L . (:, c. :\f. nrnT.T()TF.CA

COLtCCION Dt NEGOCIOS Y ALTA úl?.[CCION

THE COLLEGE AND GRADUATE SCHOOL OF BUSINESS

THE UNIVERSITY OF TEXAS AT AUSTIN

February, 1997

STRATEGIC ALLIANCES IN MEXICO.

EFFECTS ON THE VALUE OF THE FIRMS

by

Jesus Esteban Macías, MAE

DOCTORAL RESEARCH REPORT

Presented to the Instituto Tecnologico y de

Estudios Superiores de Monterrey

in Partial Fulfillment

of the Requirements

for the Degree of

Doctor of Philosophy

THE UNIVERSITY OF TEXAS AT AUSTIN

February, 1997

ABSTRACT

STRATEGIC ALLIANCES IN MEXICO. EFFECTS

ON THE VALUE OF THE FIRMS

This research lists the most important Mexican strategic alliances during the 1989-1996

period, principally the ones who issue at the Mexican Stock Exchange. The study looks for

consistency with other studies regarding causes and effects of strategic alliances on firm

value. It is based on an event study on stock retums of the acquiring firms ·finding a

significant jump close to the merging announcement, called day zero. The first test using

the event study method was done by Fama, Fisher, Jensen, and Roll in the lnternational

Economic Review, February 1969. This method, either (explicitly or implicitly) assume

that markets are informationally efficient or they explicitly test for the informational

efficiency (Starks, Laura 1993).The study proved that stockholders of Mexican merging

companies experienced on average 4.5% increase in abnormal returns around the

announcement day established at -4+8 days period consistent with other studies in

empirical evidences. The Mexican market was found to react efficiently to alliance

announcements. Reasons for the abnormal retum effect were looked to come from previous

undervaluation of stocks, financia! performance, and synergy coming from assets and

organizational restructuring. The event study was complemented by a Discriminant Model

finding that debt burden, cash flow, and missvaluation of assets and debt were found to be

significant in explaining differences among abnormal retums of the allying firms. The

economic envirorunent prevalent during 1989-1994 period was found to be acting as a

mood variable stimulating number of alliances and abnormal retums. This was related to

financia! globalization and emergent markets where alliance events have increasingly

occurred.

Aknowledgements

Abstract

STRATEGIC ALLIANCES IN MEXICO

EFFECTS ON THE VALUE OF THE FIRMS

TABLE OF CONTENTS

Introduction .......................................................................................................................... 1

Chapter I Overview of Strategic Alliances ............................................................................ 6

I. l Intemational strategic alliances : key to success ora new failure ............................. 6

l. 2: Theoretica1 background ...................................................................................... 13

Financia! restructuring and organizational restructuring ................................ 14

Value creation in strategic alliances ?-----------------------------------------------14

Where does va1ue creation come from ?.. ................................. ...... ... ....... ..... 15

Diffcrcntial efficiency ...................................... ... .......................................... 17

Inefficient management. ......................................... ....................................... 17

Operating synergy ........................... ............................................................ 18

Purc diYasification ..................................................................................... 18

Financial syncrgy ..... . .............. ..... .......... ................. .. .................................. 18

Stratcgic rcalignment ......... ..... .... ........... .. ................. .................................. 18

Undcrvaluation ........................................................................................... 19

Agcncy Prob1cms and Managerialism ........................................ .................... 20

Winncr's cursc-hubris ................................................................................. 20

Thc free cash flow hypothesis .......... ....................... .. .................................... 20

Markct Powcr. ........ . ....... .... ........ .. ........ ...................................................... 21

Tax shiclds ............. . .. .. ................................... .. ...... .... ...................... 21

Rcdistribution of Wcalth ................................................ .. ............................ 22

Cultural and organizational compatibility ...................................................... 22

Mcrgcrs undcr agcncy thcory .... ... ............ .. ........... ...................................... 23

Financia! Globalization... . ················································· ............. 23

Chapter 11 : Mexican Strategic Allianccs. 1989 - 1996 ....................................................... 26

Conccntrations.. . . . . . . . . . . . ... ... ..... ...... ......... .. .. .. .. ... .. .... .. .. . . .. 36

Privatizations of formcr public firms ....... . ............................... . ······ ... 39

Chapter 111 : Methodology ....................... .... ...... ." ................................................................ 43

H~-pothcscs ..... .. .............................. .. .......... ....... ................... ..... ................ .43

Methodology explanation ..... .. ......................................... . . ·· ··· ······ ... 51

Definition of synergy ......... .. ...................................................... .

Model for calculating abnorrnal returns ............ .............. ... ..... ....... .

. .. 51

. ... 52

Justification of thc model. ..... .. .. ........... .. .................................................... 53

Assumptions ............................. ............................... ................. ..... ... ....... . .5 5

Discrimination between high versus medium and low performers .................. .56

Short run performance .................... .. ................ .... .... ....... .... ........ ... .. .......... .56

Thintrading .......................... ........ .. ......... .. .... ....... ... ............ ... ....... .. ........... .5 8

Statistical tests on the market model... .......... .. .. ... ....... ... .. ................ ...... ..... 62

Testing significance in abnonnal retums ............................... ............. ... ....... 62

Test on sizc effect. .... ... .... ... .................. ...... ... ............ ....... .. ..... ...... .. .... ........ 64

lndustry effccts......... .......... .... .......... .. .............. ........ .. ........ ..... .. ... ... ....... . .65

lndustry and finn conccntration. .. . .. .... ........................... .. ............... 66

Data: firms alliances sample...... ... ............. .. ... ............. .................. .67

Holdout sample .................. ....... ...... ......... ... ... .... ... ......... .. ... ....... .... . . .. . 68

Chapter IV : Empirical Evidence Review ........................................................................... 70

Financia! Postmerger performance ........................................................ ....... 76

Opportunism explainning gains ..... .. ...... .......... . ············ .................. 78

Leveragcd rccapitalizations.. .. .. .. . . . ..... ..... ........ . . . . . . . . . . .. . . . . . . .............. 80

Lcveragcd buyouts and put bonds : thc cntrecluncnt hypothcsis .......... ... ........ 81

Markct sharc cffcct, pricc cffect and cost cffecL ....... ........... .. ..... ... .. .. ... ...... 83

Forcclosurc mcrgers ...... .............. ............... ... .................. .... .. .... ........ .... ... .. 85

Rclatcd and unrclatcd mcrgers. ..................... ........ ....... ..... . ..... ... .... ..... 85

Forward and backward integration. Toe use of modcrators .................. ...... 86

Acquiring firms gains and owncrship concentration .......... ....... .......... .......... 87

Joint ven tu res ..... .... .............. ........... ..... .. ............ . ........... ...... ..... .. . ............. 88

Mcrgcrs cfficiency versus markct powcr: valuation cffccts ....... . .. ...... .. ... ... 89

Conccntration po,vcr . . . . . .. . . . . . . . . . . ..... ................ . . ........... 89

T;:irgct opposition and sizc dTcct. 90

Takcovcr rcgulation cffccts on multinational mcrgcrs 91

Rol of Taxation and mcrgcr succcss ...................... ..... .... ..... ..... .. ................... 92

Contagious mcrgers ............................................................... ..... ... ..... .. ....... 9 5

Merger cffect of accounting practiccs ........................................................... 98

Prcdicting mergers..... ... .. .. . . . . ................... ......... .......... .. . . .. . . . ... .... . . ........ 99

Morale for predicting merger success .......................................................... 100

The endogeneity problem in predicting the outcome of tender offers ............. 102

Chapter V : Results ........................................................................................................... 105

Conclusions ........................................................................................................................ 140

Tables ................................................................................................................................. 142

Table 1. World flow of resources ................ ..... ........ ............................................................ 142

Table 2. International Bond Issues ....................................................................................... 142

Table 3. International market loans by most important instruments ..... .. ... ............................. 143

Table 4. Net international fk,·,,s 0fstock, 1991-1994 ............................... ..... ... .................... 143

Table 5. Canonical discriminant functions ...................................................... ... .. ........... ...... 144

Refcrenccs ...................................................................................................... .... ................ 149

Main currículum data on Mexican merging finns. 1989-1997 ............................................. 166

Vita .................................................................................................................................... 173

INTRODUCTION

In the last twenty years important economic changes were applied in Mexico.

This was thought to respond the higher international competition accelerated with the

telccommunications recent revolution.Trade and investment went into liberalization

policies that accelerated the need for rnodernization. Firms took shorter positions to

investment oppo1iunities in a Iack of capital market. Orthodox and heterodox

measures tried to stop capital outflows, mainly through increasing rates of interest,

privatizing econornic activity, adjusting for foreign exchange, and restructuring

externa! debt.

Strategic alliances were observed to increase, particularly during the 1982.

1987, and 1994 debt crises. Each of these unstable periods were followed by periods

of hyperinflation, deep recession, and Iack of externa! capital to support grov..1h.

Privatization and rnerger expansion contributed very much to the

consolidation of new huge industrial and financia! groups in México, many of them

coming from higher foreign participation in the new path of internationalization of

Mexican firms.

Consistently, monopoly regulation changed rapidly clairning social welfare

(Oficial Newspaper Dec-28-1992). However, this antitrust government behavior did

not irnped mergers and other kind of alliances, to be able to compete with foreigners.

Mergers in Mexico do not concentrate in specific areas. They cover a wide

range of activities forming huge industrial and financia! groups. As an example, the

Telmex reprivatization, on December 20, 1989, stirnulated mergers between the

strong Mexican financia! group -Inbursa- and sorne domestic and foreign companies.

Carso group merged with France Cable&Radio, and with South Western Bell, with

20.4% of controlling stock. Carso - lnbursa group covers a wide range of econornic

activities restaurants, communications, construction, industry, and sorne others.

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How the financia[ community has interpreted these merging events is the main

question in this study. Far instance, during the Telmex privatization - mer.ger event, a

71.4% increase in total revenues was reported in 1990 and 21.3%; 17.5%; and 14.5%

respectively in 1991-1993. In consequence, the stock value rose steady 32.2% in real

terms, from 1989 to 1993 (Grubman, J. 1993).

In a recent date Telmex announced a new alliance with the strong mass media

private group Televisa, to share its cable net far integral communication -phone,

electronic data interchange, fund transmissions, etc. After this announcement, Telmex

registered a 3% increase in stock price over the 3 days following the anriouncement,

an amount approximately 2.2% higher than the market retum over that period,

Simply stated, mergers mean the formation of one or more economic units

from two or more previous ones. They can be horizontal, vertical, conglomerate,

financia!, managerial, concentric, etc. Sorne estimations have been provided regarding

the rate of increase in merging events, worldwide, and for instance Gobbelies (1995)

faund that this rate has almost doubled in the nineties as compared to the eighties.

Severa! theories have been proposed to explain the merger strategy, an old

business practice, dating from 1895 in the US.

Mergers seem to vary consistently with sorne econorruc, managerial and

financia! processes, far instance the product life cycle (Porter, Michael 1985).

F ollowing this theory, in incipient industries, merging beco mes attractive to share

growth opportunities far financia! or distributional fulfillment. On maturity, vertical

and concentric merging may appear attractive to increase economies of scale in

research, marketing, production, and financia! opportunities. This is especially

important when profitability growth begins to slow down as competition increases. At

the decline stage, horizontal merging may seem attractive far conglomerates to protect

market positions and to create new entry barriers.

.)

Depending on the specific circumstances and processes in which a merger

occurs, a "win to win" situation mayor may not emerge. Sorne research has.shown -

though not conclusively- that mergers benefit stockholders of both the acquiring and

the target firms (Dodd and Ruback, 1977), emphasizing a bigger effect on target firms,

measured as stock prices increase as well as better accounting performance. Far

example, Franks, Harns and Tirman (1991) in an examination of 399 acquisitions show

that stockholders of the target firms have larger gains around the announcement.

Possible explanations of this "value creation" have been grouped into three

majar explanations: First, sorne synergy emerges from the union, as firmsL resources

are better allocated. Also these firms tend to reduce costs and/or to increase future

income. Second, previous undervaluation of assets existed prior to the merger, and

this situation is recognized and corrected far the market. Third, a redistribution of

benefits arises from stakeholders to target stockholders and from these to acquiring

stockholders through control processes.

Whatever the explanation, what seems important is that new stake-stock holder

relationships emerge creating interesting agency considerations. The mechanisms

through which this value creation or distribution occurs possibly distort asset pricing

practices, as well as formal or informal leasing contracts or direct and indirect asset

transfers. This may increase stock retum abnormally.

Previous research has indicated that the size of the stock gains at the merger

announcement depends on severa! factors. These factors are: the form in which the

merger occurs, the amount of leverage, the merging mechanism u sed, the financia! and

contracting cost process announced far accomplishing the merger, the characteristics

of the management teams and the board of directors, and the specific bargaining power

the firms have. This signaled through the financia! and organizational mechanisms

employed, principally those related to financia! complementary assets valuation

(accountability), and press news.

4

The task of this research is to look for consistent evidence in the Mexican

experience, to look for robust increases in the acquiring firms' stock returns and in the

financia! situation of these companies. Evidence will be examined befare and/or after

the merger announcement.

The first step in this research is to examine the stock returns reaction for value

creation or distribution in the Mexican merger experience. After statistical tests the

second step is to determine what financia! situations may be explaining synergy, if any,

i.e. value creation, distribution, signaling, etc.

Another question in this work is to rev1ew if the Mexican expenence m

mergers has been primarily the case of combining of assets bringing revaluaticm or the

case of a tax-treatment. Also of interest is whether these mergers may have been a

transfer of benefits from combined stakeholders to merging stockholders. lf so, sorne

tests will be performed looking for evidence regarding how the tax system and

Monopoly regulation in Mexico encourages or discourages firm concentration and/or

restructuring.

Also important m this work, is whether there exists prívate information

asymmetry creating hubris expectations, sentiment biases and/or noise reactions, as

well as other expectations.

Another question that leads this research is to estimate the bargaining power

effect in the abnormal retums merger event. For instance, the effect of a new kind of

government protection to the merger firms creating monopoly eamings, overvalued

prices or better leverage. Thus a Discrirninant model is specified to look for this

bargaining power as in Telmex, Fertimex, petrochernichal plants, and banks.

Besides employing the event study methodology to test for abnormal retums,

financia! ratios are utilized to look for market undervaluation due to rapid inflationary

periods and -or- former public ownership. Similarly, a Discriminant model is

performed to control for size and financia! performance as well as to look for

monopoly considerations or greater market control in the merging firms. Thus, the

5

research employs a combination of statistical event study method with financia! models

based on Discriminant analysis that gives us a way to account for qualitative

differences in the merging firms as well as to estímate their importance in explaining

the Mexican merging process.

Summarizing the description of this work, I considered important to resume

the main theories that explain causes and effects of establishing strategic alliances such

as mergers, acquisitions, joint ventures, etc. This was done in chapter 1. From this

theory review the main hypotheses were obtained. Also important was to review what

has been happening in other countries regarding strategic alliances, to infer sorne

specific circumstances, methodology and data collection and processing. - This was

done on chapter 2. On chapter 3, the methodology was explained and justified,

marking its limitations and possibilities. In chapter 4 a review what has been happening

in Mexico regarding strategic alliances while in chapter 5 the results were presented.

On the overall development of the work two things were followed, mainly if there was

a satisfactory response in the Mexican stock market to strategic alliance

announcements and what were the circumstances that can help to explain high

abnormal effect comparing to low abnormal effect. This obviously would have

implications for financia! restructuring schemas as well as portfolio selection and

financia! regulation based on perfect market behavior in Mexico.

6

CHAPTER I

OVERVIEW OF STRATEGIC ALLIANCES

1.1 Intemational strategic alliances: key to success or a new failure.

Some researchers affirm to have found enough empirical evidence in

interpreting different kinds of corporate restructuring as a value creation process.

Most studies base their conclusions studying how stock retums increase significantly

after a corporate restructuring is announced. These reasonings and evidences

contributed to the idea that value creation is realized in the stock market. and it is

interpreted as a successful event if, in the short run, stock prices increase by more

than the market index or whatever benchmark is employed.

Not only mergers and acquisitions fall within the concept of corporate

restructuring. Also included are spinning off divisions into independent status,

repurchasing shares or arranging le\'eraged buyouts, forming out new firms to

partially owned subsidiaries, and some other. Empírica! evidence indicates that these

restructurings create value because they are contributing to a better resource

allocation among firms.

However, other researchers doubt this value creation process always take place

because sorne of the restructurings may be followed by value destruction processes

instead of value creation processes. For instance, sorne restructurings are proceeded

by high interest debt issuance and/or sales of assets that destroy value and reduce

employment opportunities. In the US " ... during the 1980s, 557 publicly held firms of

ali sizes went private through leveraged buyouts or buybacks. The total amount that

changed hands was nearly $170 billion. much of it raised through the issuing of high­

interest debt, or junk bonds. The outcome is often similar to the outcome of a hostile

takeover -in order to pay down the debt, substantial sales of assets occur-" (Martin,

John. 1993).

7

Succcss in corporate restructuring is thus notan easy question to answer. In this

work success is interpreted in the short run as val ue creation proccsses real ized by the

stock market performance or 69 operating performance. More recently a greater focus

is given to the long run effects of these restructurings and not only to the short run

effects (see for instance Kothari, Wamer. 1995).

Sorne researchers affirm that alliance success depends on the reasons to why the

firms ally, the circumstances in which the alliances occur, and the managers· skills

dealing with economic and regulatory risks as well as the characteristics of the

merging firms.

Guidelines for successful alliances in empirical studies have concluded that

corporate restructurings have to increase competitive advantage of firms as a si ne

quct non condition for a successful restructuring. F ocusing more on unique strengths

than correcting weaknesses, financia!, manufacturing or technological transfer may

spread to both engaged firms. Very general conditions have been formulated to

forecast when an alliance can be successful or non successful.

This lack of predictability may be overcome by the market in sorne way. If not,

the question is why the stock market reacts to thc:;e announcements. Reasons may be.

sentiment, speculative behavior, managers' maniqueism, portfolio selection bias

(market imperfections), and/or information signaling plus rational behavior.

One key issue is to know how the alliance will impro\·e the allocation of the

resources as well as to how the alliance could make managers to perform to greater

competitiveness orto reinforce bargaining power.

It is accepted that management ski lis explain much of the success of the firms.

detecting opportunities and managing risks. Most of the empirical evidence and

theory agrees to conclude that success of most alliances derives frorn managerial

skills.

8

For instance, Mexico is seen internationally as an investrnent opportunity for

devcloping successful strategic alliances principally in supplying technology and

investment capital. "Companies can sell to Mexico by licensing technology,

exporting, forming a joint venture or acquiring a company. As companies will

become more vertically integrated in the Mexican market, their involvement and

control will increase, but so may their business risk. (Fraser, Dave 1992 p: 86-93).

However, management skills are not easily transferable from one business to

another. Could we believe that in an alliance, this management transfer occurs more

evenly? But, is this true? Is it necessarily true? So why stocks anticípate v~ry: much to

a possible value creation process if this process besides their difficulties.

Gundlach, Gregory T. and Mohr, Jakki J. 1992, found that competitors are

increasingly relying on collaborative relationships guided by intermediate forms of

govemance (strategic alliances, hybrids, networks) to find and maintain competitive

advantages. Such alliances contrast with what governrnent antitrust legislation

intends.

Malott, R. H. 1992 found that in any business relationship, it is important to

understand one another objectives and to adhere to one's own. Malott gives evidence

for FMC Corp. He calculated that over the past 2 decades, the proportion of FMC's

revenues generated overseas has risen from 14%-43%. Alliances have helped FMC

create worldwide scale in production, marketing, or distribution.

Among the causes of alliance failure are the absence of common or

complementary objectives, overestimated synergies, and organizations that have

incompatible philosophies and values.

Roberts, Roger F. (1992) concluded that if a business is subject to intemational

competition, it cannot afford to take a go-it-alone strategy. Managers often get

involved in a technology sharing situation that is accompanied financia! risk. Roberts

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says that combining managers and other firm capabilities accclerates firm · s

devclopment, principally in thc international operations.

Savona, Dave ( 1992) pro vides evidence on alliance failure. He recommends a

study prior to mergc and to have prepared a contingency plan in case of failure.

Managers capability on managing corporate styles and cultures is also stated to be a

key to success for international alliances.

Bronder, Christopher and PritzL Rudolf (1992) affirm that understanding the

development process of the alliance is critica! to predicting success. A "structured

procedure" for developing strategic alliances is presented in 4 critica! ph_a~s. First: it

is a strategic decision which includes situation analysis, identification of strategic

cooperation potential, and evaluation of shareholder value potential. Second,

configuration of a strategic alliance, includes deciding on the field of the cooperation

and the intensity of the cooperation as well as an analysis of opportunities for

multiplication. Third: partner selection, includes fundamental. strategic, and cultural

fit. Fourth: managing a strategic alliance, includes contract negotiations, coordination

interface, and leaming, adaptation, and review.

Lorange, Roos, Johan, and Bro11i1, ( 1992) found that answenng questions

regarding the broad benefits of the alliance, how the two parties can complement each

other, and the managerial capacity of the firms is key for success. In the more

intensive phase of the formation process, the prospective partners should address

questions concerning market potential, key competitors, worst-case scenarios, and

cornpetitive advantages of the alliance. Additionally, they mention to also look at

political considerations in forming strategic alliances. The support of interna! and

externa! stakeholders must be lined up early on. In the intensiYe phase, managers and

others who might be active in the alliance are the key people to consider.

These findings are becoming highly mentioned in similar studies on

forecasting the effects of a corporate or organizational restructuring. Most of the

10

empirical studies agree that selection of thc right partner is fundamental. Senior

management commitment and clear communication between partners are critical

paths to success. Overly optimistic expectations, poor communications, arÍd lack of

shared benefits are among the reasons for alliance disintegration.

Magee, John F. (1992) found that while there are a number of risks involved in

formulating an strategic alliance, technology gains overcomes very much the risks

absorbed with technology improvement can cut costs, increase the bottom line, forge

synergies, and secure a competitive advantage. Alliances may be the fastest and most

cost-effective way to gain technological competence. Also he remark~d._ that the

problems rose among partners involves control, the shifting balance of power and the

fear of losing competitive advantage. Among the major causes why sorne US

alliances did not succeed were a lack of careful management and not extracting all the

advantages from the agreement.

Levinthal, Martinez, Quelch, and Ganitsky, (1993) found key to success for

Latin American company mergers the external causes around it. They mentioned the

recent política! events, the economic policies, true reforms, regional integration,

geopolitical forces, and Latín American firm' s characteristics. They also subs•.:rib~

that the mode of entry will anticípate success or failure. Sorne ways to enter the Latin

American market they mentioned are: exporting, doing strategic alliances, creating

in-bond assembly plants, acquisitions, and green-field investments.

Flanagan, Patrick (1993) concluded from an interview with Jose A. Collazo,

chairman and CEO of Infonet Services Corp., that a strategic alliance should not be a

quick-fix to a problem; the strategy should be based on the benefits that the alliance

brings to both parties. Therefore during the alliance negotiations, the most important

aspect is to retain the ability to walk away from the deal.

Collazo distinguished many reasons for establishing strategic alliances:

• fil! in gaps in the current market and in the technological availability of each firm. • turn excess manufacturing capacity into profits.

11

• reduce risk and cntry costs into ncw rnarkets. • accclcrate product introductions. • overcome legal and trade barriers. • extend the scope of existing operatíons. • cut exit costs when divesting operation. • cconomies of scale.

Valigra, Lori (1993), also interviewed Mobuo Mii, general manager of IBM's

Entry Systems Technology business unit. They talked about the future of PC

development. He believed that Japanese companies are not that loyal to

stockholders. New technology needs more than a one-company investment, and

therefore this faster technology diffusion means that strategic alliances and joint

ventures will become more frequent. For example, IBM is in an alliance with

Toshiba for small, flash memories and flat displays and with Toshiba and Siemens for

dynamic RAM chips. Based on this interview Valigra concluded that technology

transfer could be a good predictor for alliance success.

Wood, Freddie ( 1993), studied the textile industry and concluded that over the

. past 4 decades, the textile industry has had a revolutionary change. In the l 990s, 2

trends forced change: globalization and consolidation.

Globalization entails free trade with Canada and Mexico, anticipating that

succeeding textile firms will have 4 characteristics in common in which strategic

alliances have predominance: appropriate strategies, world-class manufacturing,

flexibility and speed, and information as a competitive weapon.

Silverman, Susann (1993), analyzed the strategy for The Continuum Co., a

$124-million software maker, which has become the largest international provider of

software for insurance companies. Silverman concluded that taking market

opportunities is the key to predicting merger success, though the investment could be

or not related to the main source of business. The Continuum most recent acquisition

was in August 1993, when it paid $63 million in stock for the world's number three

insurance software company, Paxus Corp. of Sydney, Australia. The purchase of

12

Paxus nearly doubles Continuum's size to $246 million. Continuum now gets sorne

$200 million, or 81 % of its sales, from foreign markets. Just two years befare

Continuum had rnade another key Australian acquisition, sorne $30 million with that

38% of sales, carne from abroad.

Fahim-Nader and Vargas, (1993) provide evidence of how to improve

diversified mergers within large firms foreign direct investrnent. Managing

intercultural differences seemed to be the cue for success, as well as market

opportunities.

Hunter, David (1993) g1ves empirical evidence of market shar.e as an

explanatory variable for merger success. He refers to manager Bolduc plan to expand

Grace's water treatment business with Aquatec. According to Ian PriestnelL President

of Grace Dearbom, the acquisition gave Grace just over 29% share in South America

(excluding Mexico and Central America) and nearly 50% in Brazil.

Newell G. Roberto (1992), concluded that privatizations are a good source of

strategic alliances, most of them successful in terms of abnormal retums.

Opportunities for large profits were observed in the bidders of the telephone

companies of countries moving to privatize their govemment-owned telephon-=

companies. In 1990 Ameritech and Bel! Atlantic bought Telecom New Zealand for

$2.46 billion. In July 1991, they offered 725 million shares to the public, which

brought the companies a profit of $150 million befare underwriting costs. The

investment gave 22% retum in the first year.

Mirchandani, Dilip K ( 1 992), cites adequate diversification as the main reason

to succeed in generating stock profits. This is done by combining product lines and

consolidating physical facilities as well as expanding the intemational market. For

instance in the last 6 months, there has been a major push into the Caribbean as

countries, Mexico, and Eastem Europe expanding intemational operations ..

13

Morris, Gregory (1992) studies related mergers to explain and to predict

merger success. He studied The Westlake Group (Houston) which is the kcystone of

Chao Group Intemational, This firm was founded in 1957 by Taiwanese enfrepreneur

T. Chao. Beyond its established regions, Westlake is investing in Mexico and wants

to take part in the growing Asian markets as well. Currently, it operates businesses in

conjunction with Himont, Mitsubishi Corp., for the petrochemical division.

According with the author, the key seemed to be diversification, thus taking what the

firm identifies as market or technological opportunity which has to be taken fast.

I.2 Theoretical background

Strategic alliances are different kinds of agreements, formal and/or informal that

can be simple collaborative agreements to more formalized joint ventures, i.e. a

merger1 or an acquisition, where two or more firms join partially or completely, to

accomplish sorne general or specific goals generally to increase competitiveness and

create value.

Mergers and acquisitions, manufacturing contracts, distribution channel

contracts, collaborative agreements, network agreements, international management

contracts, and others, such as franchises and supplier agreements are different kinds

of strategic alliances that integrate businesses processes to foster firms' financia!,

manufacturing, and/or marketing objectives.

I l\lcrgers and Acquisitions. Thc most common financia! proccdures used in mergcrs and acquisitions, are: - l'ublicly lraded limitcd partnershirs - Employec stock oplions plans - Lcvcraged buyouts, named as U)O's - Public offcring ofstocks which can be acquired. liquidatcd, and bankruptcy. - Lcvcraged management buyouis - Lcvcragcd rccaritalizations - Scllolls and SrinolTs

14

Financia! restructuring and organizational restructuring.

Financia! restructuring alters the cornposition of the firm' s asset portfolio or the

claims against those assets. It takes a variety of forms, which fall i"nto broad·

categories: rnergers or reverse rnergers, the latter including divestitures, spinoffs,

splitups, stock repurchases, partial public offerings, and leveraged buyouts.

Organizational restructuring includes chariges that are not only related to cost

reductions but to a better use of available resources. Arnong the important

organizational ch,mges rnost repeated are the change in the board of directors, the

change in the CEO, the change in the managers compensation policie~, :.ª relative

downsizinrr ;ind optirnization of the firm operations, and so on.

Sorne other difficulties regarding the characterization of strategic alliances anse

the new with complexity of the financia! instrurnents. F or instance, a swap agreernent

can establish a future interchange of assets or liabilities between two firms; This

agreement could not be accounted in the financia! statements and thus, not realized by

the investor community as an alliance.

After the financia! restructuring takes place in a swap agreement, the firm can

take advantage of tax allowances, cash flow stabilization, and assets expansion. The

firm is not longer the sarne because we ignore the future compromises the firm has to

fulfill in sorne sense they have allowed their financia! statements.

For instance, when doing off-balance agreements, like a swap contract, we said

that financia! information is no longer valid. It lacks of consistency in showing

profitability and risk in the valuation. This situation may arise rneasurement errors

and create sorne irnportant biases principally if the off balance practices becorne a

comrnon practice without an adequate rule for disclosure.

Value creation in strategic alliances?

15

There is controversy about how of value creation takes place in a restructuring

process. Sorne people argue that value creation is a si ne qua non condition in a

strategic alliance, insisting that value creation is the primary objeciive when

undergoing a restructuring. Others, however, insist that accounting and tax practices

that make value creation tacit and thus a problem in the long run. This value created is

not casy to sustain often the alliance

For the U.S. financia! market one study has estimated a total of $400 billion in

mergers and acquisitions from 1977 to 1986 (Jensen, 1991 ). The author concluded

that this big wealth effect resulted in more efficient utilization of corporate a,ssets.

However, sorne mergers such as those that occurred in forceable or hostile

circumstances, could result in value destruction rather than value creation. Peter

Drucker (1986), for example, contends: "There can be absolutely not doubt that

hostile takeovers are exceedingly bad for the economy". Acquired companies, he

says, are so burdened with debt as to severely impair the company · s potential for

economic performance. He states that takeovers precipitate the sell off of the most

Yaluable parts of the acquired businesses, destroying synergies that previously

existed.

Further, "The Business Roundable", comprised of the chief executives of

America · s 200 largest corporations, has agreed with Drucker, contending that hostil e

takeovers "create no new wealth, but merely shift ownership and replace equity with

large amounts of debt". The concem is that short-sighted institutional investors

undervalue companies whose current eamings have been temporarily depressed by

eff011s to invest for the long run. (Martin, John 1993).

\Vhere does value creation come from?

Research has shown that mergers can benefit stockholders of both, the acquiring

and target firms (Dodd and Ruback, 1977). In fact, rnergers were known during the

16

sixties and seventies as "the 2 + 2 = 5" effect, a form of synergy creation.

Explanations about where this value comes from are related to different theories

(Weston, Fred. 1990).

The possible explanations can be grouped into three major explanations:

1.-some synergy emerges from the union, because firms' resources are better allocated.

II.- previous undervaluation of assets existed prior to the merger

III.- there is sorne redistribution of benefits from stakeholders to target stockholders

and from these to acquiring firms through control processes.

The reasons why value creation takes place with the alliance among. the most

mentioned are undervaluation, leveraging, and signaling.

Undervaluation in target stocks occurs as a result of large inflationary periods

and long public ownership. This makes mergers a very profitable business for target

firms, however the increased value is now shared with the acquirers.

Leveraging is referred to be explaining why target stocks increase the most.

Leverage reduces dividend disbursements so favoring cash and increasing after tax

retum. Also, it stimulates managers performance.

Favorable signaling is referred to be present in explaining higher variation in

the target stocks, because a low price is interpreted by investors befare the merger

process. Different reasons explain motives and results for mergers.

Combining assets and creating moriopoly power in sorne restructuring countries

has explained merger gains. Tests for market concentration have been performed to

account for socially unfair distribution of benefits resulted in merger processes.

Protection from government in mergers is an additional source of value

redistribution for its impact on monopoly creation, tariff protection, over regulation,

and overpricing.

17

Tax advantages Cor mergers is other variable that has becn spcciiicd to cxplain

higher stock variations. However. as it will be seen in the next chapter, most studies

have found this variable to be of low reliability and low significance.

In many countries the "noisc" or sentiment theories hold that mergers create

hubris expectations that exceeds value creation so a lower postevent stock

performance would be observed correcting the announcement stock variation.

Downsizing is also in the '"name of the game ., for man y mergers: spinning off

divisions into independent status, repurchasing shares or establishing leveraged

buyouts, forming out new owned subsidiaries and so on are part of the same .process.

Sorne other important remaining theories for why mergers occur and they are

said to create value are:

Efficiency theory: Agency theory; Managerialism theory; Winner's Curse -

Hubris theory; Free Cash Flow theory; Market Power theory; Taxes theory;

Redistribution of Wealth theory: Govemment Privatization theory, Cultural and

Organizational Compatibility theory, and Financia! Globalization theory,.

Efficiency theory2 has severa! expressions. Among the most mentioned are:

Differential Managerial: Inefficient ivfan2.gement; Operating Synergy; Financia!

Synergy; Pure Diversification; Strategic Realignment and Undervaluation theory.

Differential efficiency

This theory presumes that the acquiring fim1 is more efficient than the target

one -or viceversa - in terms of management or operations, so there is an increase in

social value from the merger that makes investors to raise their price expectations.

Inefficient management

: A capital market is efficient ( 1) if it does not negleciany infomiation relevant to the determination of sccurily priccs. and (2) if it has rational e\pcciaiions (Fama. 1976)

18

According to this theory, Mergers result from the idea that some other

management group can run the business 111 a better way, due to cultural or

geographical advantages. This theory proposed the idea of mergers· between

companies that are not distinctly related, but led by efficient managers temporarily

will perform much better. This argument has been used to describe the period of

government enterprises during the thirty years after the 1929 crisis.

Operating synergy

Economies of scale result as a consequence of indivisibility, complementary, and

better utilization of capacities after merger. This theory applies to vertical and

horizontal integration that increases communication and coordination while reducing

bargaining costs and other wastes. The accepted Financia! Wisdom (Doctrine) from

Jensen (1984), refers to the company's increased productivity in achieving positive

stock price changes, rather than from market power.

Pure di versification

Mergers increase value due to investor preferences for diversification,

reputation, and tax advantages. Risk is said to be reduced, as a result of tumover and

reorganization. So, it is expected that the overall measure of returns increases.

Financia! synergy

In this theory, the cost of capital is reduced as a result of lower bankruptcy

risks. This theory assumes that the cash flows between the two firms are not perfectly

correlated, so the merger will benefit debt holders at the expense of shareholders

(Higgins and Schall, 1975). Financia! synergy, also describes the idea of excess cash

flow in bidders and good gro\v1h potential in targets. Many successful mergers

19

appcar to be related to this theory. For examplc, the merger between Phillip Morris

and General f oods in 1987, allowed Phillip Morris to combine their cash flow (but

low growth potential) with the high growth potentiai (low cash flow) of General

Foods.

Strategic realignment

From a strategic point of view, changes in the environment call for rapid

adjustments among firms to gain competitive advantages, or simply to survive.

Merging suggests the idea that long run strategy is taking place and so!'Tle other

favorable announcements will be given. As a result the the market will create

unexpected synergies. This long-run view contrasts greatly with the short run excess

cash flow theories, where rapid adjustments occur in the market.

Undervaluation

Because of agency considerations, long term investments are undervalued by

investors (prohibiting short term earnings), so they become attractive for raiders and

when merged, result in stock increases. Also, as a resHlt of long periods of inflation,

replacement costs increase more rapidly than stock value, making it more profitable

to merge than to build a new company. This theory may be highly valid in Mexico,

where merging increased after short periods of three digit hyperinflation.

Information and signaling

An alliance conveys information to the market that it had not realized befare.

For instance that the merger will strength both companies. Thus, brands multiply for

both companies, so the market anticipates value creation through brand synergy.

Recent theoretical research on market efficiency 11 links expectations with

information, saying that the investors are able to gain sorne information from prices.

20

Therefore, rational cxpectations are csscntial to markct erticicncv so mcrgcr

information is csscntial.

Agcncy problems and managerialism

When managers own a portian of the firm's equity, they may become more

interested in merger possibilities than otherwise because of the potential increase in

their stockholdings . Very often this theory anticipates low success from a merger

due to inefficient alliance investments. Additionally, managers seek to protect their

privileges, or even more to increase them, and they find mergers a good \\.'.ª):'. of doing

so; their salaries become adjusted to the size of the firm. Therefore, expenses grow

and dividends may fall.

Winner's curse - hubris

Managers of sorne bidding firms may assess the target value higher than the true

value for presumptuousness or hubris (Roll 1986), therefore, the bidders firm

reputation increases due to a combination of psychological and informative

imperfections. Market may react to to.is overestimation increasing hubris

expectations. No value is created so it expects in the long run it will adjust downward.

The free cash flow hypothesis

Excess cash flow would usually be paid to the shareholders as dividends, but

this would reduce the amount of resources that managers can control. Managers tend

to prefer short term retums rather than long term retums.

Thus, managers tend to invest the free cash flow in mergers or to increase debt

in exchange for stock (Jensen, Michael 1988) which conflicts principals in the short

run. while it promises higher long term returns. Thus, the mechanism utilized to ally

will anticípate higher stock returns.

21

Markct powcr

Alliances rnay increases market share for the acquiring firm, whether or not

this be necessarily good. If the new cornbined companies'market share is higher than

the eme allowed by the government, there may be more problems than advantages

(antitrust regulation). Economies of scale and power considerations are more

important to stimulate mergers if cartels are allowed or tolerated. lf this is not the

case. too concentrated market power may discourage consumers in buying in such a

market. Competition means to consumers an attraction regarding quality_ and fair

price; this may increase international demand and the perspectives of the firm become

favored.

Tax shields

Theory affirms that mergers may be tax induced only if there are no other

forrns of obtaining the tax deductions. Mexican legislation <loes not allow the transfer

of tax credits between separate firms, although managers can find sorne other ways

for transferring legal allowances. According to this theory, taxes niay affect mergers

rate to take advantage of tax allowances (Smirlock. Beatty, and Majd. H. 1986). This

theory indicates that target stockholders will be taxed higher because of capital gains.

Nevertheless although tax allowances may influence the decision to merge, they are

not the important factor.

A legitimate business must exist apart from the tax advantage. Otherwise the

merger is undesirable. regardless the availability of tax credit. For instance recapture

of depreciation allowances due to mergers mitigates the incentives. Similarly, good

will. which is not tax deductible. stimulates mergers, and can be much more

important than tax shields in the long run.

22

.Iones and Taggart ( 1984) combined !he !ax thcory with the theory of the life

cyck ancl rcach intercsting conclusions. Thcy say that young iirms lind merger with

high taxed firms, favorable because the formcr has more expenses than income. When

thc younger finr. grows, it becomes more attractivc to sell it to a corporation.

Afterwards the organization will be better off in the hands of low tax firms such as a

royalty trust or another younger firm.

This theory seerns appropriate for small and medium cnterprises

technologically advanced, such as computer components, software, specialized

sen·ices and so on, where economies of scale exists.

Redistribution of wealth

In a merger sorne redistribution occurs among stakeholders. Value may shift

from bondholders to stockholders and from labor to stockholders or consumers

(Asquith and Kim 1982: Dennis and McConnell 1986). For instance, when

leveraging, the firm cash flow increases, managers compensations increase and

possibly consumers' welfare reduce as prices go up.

Cultural and organizational compatibility

One of the most important new paradigms that are leading the expansion and

development of alliances worldwide is that cooperation has to be combined

appropriately with competition in arder to compete successfully. Speed and pace in

strategy implementation orients critica! decisions in a world of superior products and

internationalization. Today's decision maker needs not only to function m a

competitive and hostile environment but also to be able to cooperate with other

companies. perhaps even with one that. in other respects. is his competitor.

For many multinational firms. strategic alliances have become increasingly

important tools for cnsuring specd and tlcxibility ll1 carrymg out thcir businesses

strategics. Firms engaging in allianccs. it was recognizcd save rcsourccs. time. and

energy by combining projccts, resources. clicnts. etc.

For instance, Fiat-Geotech saw the need to changc its strategy to onc of

cooperation with others. To avoid an anticipated increase in European protectionism

and to attempt to enlarge its markct share, HCM began to search actively for a joint

venturc partner in Europe. This resulted in 1987 in Fiat-Hitachi Excavators SPA with

in a 51/49% joint venture to manufacture and thc market a new Iine of hvdraulic

excavators in Europe.

Mergers under agency theory.

Severa! explanations regarding reasons to ally are derived from agency theory.

According to these explanations tax shields, managers bonus-oriented behavior, of the

lack of adequate monitoring of managers create a tendency for sorne firms to establish

strategic alliances. These explanations are based on the belief that managers

controlling more companies should earn more. This stimulates alliances and if

managers are owners there will be a tendency to look for underYalued companies, to

buy them and to take advantage of stock appreciation as weli as tax shields increasing

debt/equity ratios.

Financia! globalization.

Among the theories that explain the causes and circumstances under which

alliances occur, the one related with the internationalization of capital has particular

relevance for this study. Lower international entry regulations, trade liberalization, as

well as the expansion of information systems sho11ened the intemational product life

cycle so creating the need to rapidly cover wider markets ..

Changes in the international financia! market accelerated the intemational

capital mobility with that volatility went up. This. ho\,·ever, has permitted developing

24

economies to reccivc big inflows of capital, not only to the bond markct but also to

the stock market. Alliances in this process, increased consistently with the higher

international sharc in stock trading -and issuance- by foreign institutional investors.

Financia! globalization is defined as the generation of a market structure

characterized by the flows of capital at world leve! by international and national

agents who induce a greater diversification and expansion of the sources and uses of

financia! funds (Mexican Stock Warehouse, 1994).

Financia! globalization has changed portfolio management looking for higher

returns. This stimulated higher volatility interest rate during the eigh_ties. Thus

im·estors found in alliances high expected retums.

In this context. Mexico went into the world economic integration. Its inclusion

in the General Agreement on Tariffs and Trade (GATT) and the recent decision to

form part of the trilateral Free Trade Agreement with the United States and Canada,

accelerated Mexico s is financia! and trading globalization process.

Different sources of funds emerged altogether with LDC21 debt problem. The

greater mobilization of international funds shrank world interest rates, exchange rates

~md inflation rates. This changed the ways firrns used to make businesses. Finance

oriented corporations looked for a reduction in their financia! costs from traditional

banking to other self-financing methods such as mergers.

The intemationalization of Mexican sources of funds increased the issuance of

convertible bonds, options, and ADR 'son Mexican shares in other countries.

There new financia! instruments enabled alliances principally the ones related

to the securitization of assets. The sale and trading of bank loans with securitized

stock as collateral and the issuance of securities that act as substitutes for loans (such

as commercial paper, floating rate promissory notes and europromissory notes) as

\vell as their sale in thc secondary market helped foreign firms to approach each other

signalling thc market to stirnulate allianccs.

25

The devclopment or financia! markets supported the idea or firms risk sharing.

This stimulated the expansion of international capital flows, specially since 1985.

This flow went from $444 billion dollars in 1985 to $5.1 trillion dollars in 1995. The

decline in financing for developing countries was offset by a higher leveraging of

banks and prívate firms from emergent bond markets

lssuance of bonds from emergent markets grew considerably. Total issues rose

from $38 billion dollars in 1980 to $256 billion dollars in 1989, and $800 billion in

1994, an increase of more than 1000% in the period.

Sorne money carne to developing countries as investrnents but most on

securities bascd collaterized loans. In the 1983-94 period there was a net reduction of

funds for LDC countries increasing capital expansion through banking, directly to

company, and through the rnarket system, which opened an increasing process of

international strategic alliances, principally mergers and acquisitions.

The greater foreign participation in developing countries' stock rnarkets was

concentrated principally by institutions such as pension funds, insurance companies,

investment funds, and for big companies and big investors. These assets grew at an

annual rate of 18% frorn 1987/1994. The argentine rnarket grew 250%, Mexico

260%, South Korea 85% and Taiwan 310%, while the developed markets grew only

13%.

Price/eamings and price/book value ratios were lower on average in LDC

countries relative to developed countries. This financia! expansion accelerated

mergers, acquisitions, and other strategic alliances in Mexico.

26

CIIAPTER II

MEXICAN STRATEGIC ALLIANCES: 1989-1996

In the last few years there have been a number of impor1ant stratcgic allianccs

in Mexico. A review of few most recent ones is presented here.

According to a study from The First Boston Corporation. mergers and

acquisitions, including privatization in Mexico, totaled $7.2 billion in 1992. In

addition and Mexican companies issued $4.3 billion in equity on New York stock

exchanges. This feature was similar throughout the early 1990' s. For_ ~\'.ample

Telefonos de Mexico alone amounted to $1. 76 billion from the privatization in

1990 and the subsequent equity offerings.

On September 1992, there was announced a $520 million investment of Bel!

Atlantic in Grupo Iusacell, the national cellular carrier in Mexico that competes with

Telmex. This merger opened a strong competition in a previously monopolized

market.

Rodrigo Calderón, from Siemens- AlcateL announced the acquisition of

Teletra Industrial SA de CV with presence in Italy, Spain, Brazil and México.

Another strengthening in Alcatel operations was the merger with Rotwell Inc.

Besides it is targeting Italcable and Stet, with operations in Italy.

Northern Telecom initiated joint ventures with Matra from France and STC

from England, to build submarine cable for Mexican-European communication.

Also important is its association with Motorola to forro the firm Motorola Norte! to

expand the production and service through networks. Also importan! was the

agreement with Nippon Telegraph and Telephone Corporation. With these alliances,

competition in telecommunication services has been growing in México.

McCarthy, Joscph (1993) studied the most important cement company m

Mexico, Cementos Mexicanos, (Cemex). This company shelled out SSOO million in

27

1989 to acquirc cemcnt companics in Mexico, Texas, and California and another

$1.9 billion last year far majority holdings in 2 Spanish cement companics. as well

as investments in Nicaragua and Venezuela. The acquisitions made Cemcx the

largest cement company in North America and the 4th-largest in the world.

Howevcr, McCarthy says Cemex disappointed shareholders, who worried that

the company was no longer the monopoly in the Mexican construction market.

Investors, particularly U.S. investors, have questioned the amount of debt needed to

finance Cemex the transactions and has expressed doubts regarding whether If the

company has sufficient international management expertise.

Moody's Investors Service placed Cemex's senior debt rating on re\'Íew after

the Spanish purchases, although the company rnaintained its Ba-2 designation. For

the year ended December 31, 1992, Cemex sales jumped 29% to $2.2 billion while

net incorne rose 24% to $548 million, including $8.5 million from the Spanish

compames.

Is the telecommunication industry, Telecommunications Inc. agreed to acquire

Grupo Televisa while Grupo Azteca (Channel 13 on Television), his competitor,

formed an alliance with NDC.

Peagam, Norman; Marray, Michael (May 1993 p: 133-134) studied \1exico's

Grupo Televisa which grew as the dominant media empire in the Spanish-speaking

world, involved in network and cable television, radio, the music business, and

magazme publishing throughout its home markets - Spain, the US, and Latín

America.

Televisa dominates the Mexican television market, with an estimated 93% of

the audience. In 1992, sales grew by 33 .5% to N$4.23 l billion ($1. l 08 billion),

65% accounted from television revenues. Operating profits grew 57% to N$643

million.

28

Nafta incrcased the potcntial far advcrtising in Spanish so Televisa increased

value evenly since 1990. Besides television high market share. in July 1992,

Televisa became the biggest publisher of Spanish-language magazines in the world

as a result of its $130-million acquisition of the Latín American and US businesses

of America Publishing Group. The high speed of expansion is being matched in

Latin America, with sorne other joint ventures or acquisitions in Peru, Chile,

Venezuela, Argentina. and Mexico itself.

Hartshom, David, (1993) reviewed the joint venture of PanAmSat with

Televisa in 1994. Grupo Televisa SA agreed to invest an aggregate amou~1L_of $200

million for a 50% senior equity position in PanAmSat's global satellite

communications system. The backing equips Anselmo has to compete more

extensively against Intelsat; The alliance also enables Grupo Televisa to establish a

stronger presence intemationally linking key Latín American markets with the

world.

The researcher said that Grupo Televisa's investment, along with other

financing obtained from PanAmSat, will be used to build, launch, and insure 3

additional satellites that PanAmSat has contracted to purchase frorn Hughes Aircrdt

Co. With the existing PAS-1 satellite, the new satellites will cover the Atlantic,

Pacific, and Indian ocean regions, creating the world's only privately-owned global

satellite communications network.

Conger, Lucy (1993) rated the privatization of the Mexican financia! system

as one of the world's most successful privatization programs where the more salient

feature was the overvalue paid to the govemment. as well as the formation of

corporate financia! groups within the Mexican financia! system. Of the 18 banks that

the govenunent sold off, 12 were bought by brokerages, having paid 2.5 to 5 .3

times book value for their banks

29

Thc main characteristic in thc privatization of thc banking systcm was the

clash bctwcen the brokerages and the banks to form these Financia! Uroups.

Santillan, Roberto ( i 995) also studied the privatization process of the Mexican

Banks, concluding that significant value creation took place.

Concentration of financia! power has been supported by the Mcxican

Governmcnt (recall from 60 to 19 institutions). Mexico's 1990 Financia! Groups

Law provides the legal framework for a universal banking system. The government

hopes that a few dominant institutions will be both easier to regulate and more

internationally competitive.

Profits in the financia! groups have been huge, but in the 1995 debt crisis

these institutions claimed higher government support via Fobaproa, a former trust

from Central Bank, Banxico. Fobaproa banking capitalization objective is giving

rapid results. The capitalization process increased bankers resources and at the same

time more government support. However, the magnitude of the crisis woke mergers

and strategic alliances to be formed to exchange new capital -mostly foreign- for

debt, overcoming capitalization problems in the short run. Within the most recent

strategic a.lliances and mergers regarding the banking system have been the

following:

In February 1995, Banamex entered into a joint venture with American

Express to issue Gold Cards to Mexican consumers. With deposits of $25 billion,

Banamex controls almost 25% of the country's deposit base, including 50% of

Mexico City.

Banoro and Bancreser merged to position number 8 in the financia! system.

Banco Union (who had restructured BCH bank) merged with Cremi, a former mine

specialized bank. Months Iater, Banca Cremi and Banco del Centro joined together

and formed an alliance with Banco Santander (Spain) in 1996.

30

Grupo Invcrlat-Comermex mcrged with Bank of Montrcal in 1995 whilc

Grupo Financiero Bancomcr (thc second largest bank in México) formcd alliancc

with I3ank of Toronto in 1996.

Other institutions are looking for partners as well as sorne foreigners are

targeting other Mexican financia! survivors, as Banco Internacional who formed an

alliance with Portuguese institutions as well as Banco Central Hispano in 1995.

Following its globalization objectives, and after expanding operations to UK.

Spain, Taiwan and South Korea, Metropolitan Life has acquired 24.5% interest in

Seguro Genesis, a Mexican carrier. Madrid-based Banco Santander joined Met with

a matching 24.5% holding. The remaining 51 % is held by Mexican investors.

Seguro Genesis began issuing life and pension products August 14, 1992. with Met

providing administrative support and advice.

The insurance broker Johnson & Higgins (J&H) is forging ahead with plans

for increased trade between the US and Mexico by acquiring 25% of the largest

broker in Mexico, Brockman y Schuh.

Besides the financia! institution, Wood Andrew detected information

regarding the 1993 acquisition of ABS by General Electric Pbstics Mexico. GE

acquired the commercial acrylonitrile butadiene styrene (ABS) operation of

Industries Resisto! SA (IRSA), part of the Mexican conglomerate DESC. This

conglomerare issues in the Mexican brokerage house as well as it has issued debt

paper and ADR s in USA.

Humder and Alperwicz (1993) provides inforrnation regarding the red iron

oxide pigments business. New entrant Laporte, bought Silo, the 3rd largest producer

worldwide in January 1993 for $9 million. With this acquisition, Laporte is

competing with Bayer, the leader and the number 2 worldwide producer Harcros.

This latter bought Pfizer's iron oxide business in 1990 and Northem Pigments, the

solc Canadian producer. in 1991.

31

Laportc entercd the business 111 early 1992 with its USO $60 million

acquisition of formulator Rockwood. In Mcxico, the numbcr 2 produccr, Hako, a

subsidiary of holding company Gerlo, bought the number one producer De Mato

from Fero in 1992.

A very mentioned Mexican mcrger has been the $477 million acquisition of

Grupo Modelo by Anheuser-Busch Cos. Inc. who agreed to acquire approximately

18% of Grupo Modelo SA de CV. The investment agreement, gives Anheuser­

Busch an option to purchase up to 49% of Grupo Modelo over the next 4 years.

However, the investment agreement does not include new distribution arrangements.

Grupo Modelo will invest half of the proceeds from the sale in expansion,

including a brewery in the state of Zacatecas. The remainder will be divided among

the existing partners, who have continued controlling the company.

Hidrosina S.A.de C.V., a group of prívate Mexican investors led by 3

entrepreneurs, purchased 30 gasoline stations in Mexico City from Petroleas

Mexicanos (Pemex), the state-run monopoly. The historie move could signal future

joint ventures with foreign marketers.

The Pemex divestiture could create sorne important companies as well as

stimulates sorne interesting mergers. For instance, distribution of liquid gas for

domestic use was privatized in the State of Mexico and Querétaro. Also , Pemex had

announced the creation of two new firms that will merge to Grupo PMI Comercio

Internacional (PMI Holdings North América, Inc. and PMI Norteamérica, SA de

CV).

Currently other firms that are subsidiaries of PMI outside the country are PMI

Holdings NV, in Curazao, Antillas Holandesas; PMI Holdings BV, in Amsterdan,

Holland, and PMI Services B V, also in Holland. Also, PMI Services North America

INC. with a branch in Houston, PMI Services Europe, L TO, in London. England;

32

Pemex Internacional Espaí'ía, SA. in Madrid, Spain, and J>MI Trading LTD, in

Dublin, Republic of Ireland.

Alperowicz, Natasha (Nov. 1992), studies new trends in thc cngineering and

construction industry. She mentions two important new paths: the acquisition of

proprietary technology and the drive to get more international business, usually

through an acquisition or alliance with a regional partner. Another trend is achieving

preferred contractor status. Researcher Alperowicz found in The North American

Free Trade Agreement an upper interest in Canada · and Mexico for strategic

alliances. Therefore, in November 1992, Fluor Daniel Inc., (lrvine, C::<!lifornia)

a1U1ounced an exclusive association with ICA Industrial (Mexico City).

Other interesting recent alliances in Mexico have been the one of Empresas La

Moderna with Asgrow Seed Co (USA) on November 7, 1994, Banacci ( Mex) with

MCI (US) on October 17, 1994; Wall-Mart and Cifra and Dillard Department Stores

(US) on October 14, 1994; GF Bancomer and VISA (Mex) with-GTE Corp (US) on

September 27, 1994; Refmex of Industrias Penoles (Mex) with Indresco (US) on

August 16, 1994.

Also interesting have been the alliances bdween Baja Celular of Grupo

Protexa (Mex) with Motorola (US) on June 23, 1994, joint venture; Parker Lafarge

(US) with Cementos Mexicanos (CEMEX) on May 18, 1994 to sell a cement plant

in New Braunfels, Texas; Consorcio G. Grupo Dina S.A. de C.V (Mex) with Motor

Coach Industries International, Inc. on January 28, 1994, merger agreement.

Kayser-Roth Corp (US) allied with Grupo Synkro (Mex) on November 23,

1993; Grupo Mexico (MEX) with ASARCO (USA) on November 13, 1993;

Rodman & Renshaw Capital (US) with Abaco Casa de Bolsa (Mex) on November

1993; Compañia Industrial de Parras (Mex) with Cone Milis Corp. (US) on March,

1993.

33

Fomento Economico Mexicano (Femsa) with Coca-Cola Co (US) on March

25. 1993; Fomento Economico Mexicano (Femsa) with Philip Morris (US) on

December 3, 1992; Geo New York Life (Mex) with New York Life Worldwide

Developments on September 23, 1994.

Valves and Pipe Fittings, NEC (Mex) with Kitz Corp of America on July 14,

1994 "plan joint venture"(in negotiation); Del Monte Foods Corp (US) with Group

of Investors on June 27, 1994; Mobilon with Nextel Communications June 6, 1994;

AXA's ( Mex) subsidiary Alimentos with Lee (Sara) Corp/ AXA on March 2, 1994.

A Group Led by Carlos Cabal Had Agreed to Buy PPI Del Mont~ Fresh

Produce. Backed by the Mexican government, the Cabal group will purchase PPI

Del Monte from Polly Peck International PLC for $500 million. The move by

Grupo Cabal represented a bid by Mexican agribusiness interests to become bigger

players in the world fruit market by acquiring one of the big names. Unfortunately,

this alliance had problems to succeed for judicial problems of Mr. Cabal.

Technology Corp (USA) on November 20, 1993 established a "Joint-Yenture"

Grupo Azteca (Mex) with National Broadcasting Co (NBC) November 16, 1993,

"plans to acquire interest in". Ford Motor Company's Favesa S.A. de C.V. with

Lear Seating Corporation, a subsidiary of Lear Holdings, on November 1993

completed the previously announced purchase of most of shares. Electroforjados

Nacionales SA de CV with Harsco Corp. on November, 1993. Tapetes Automotrices

Mexicanos SA de CV Tamex with Collins & Aikman Corp (Doblin Textiles) on

November 1, 1993.

Yirmar Telecomunicaciones SA de CV with American Telephone &

Telegraph Co ATT on September 23 1993. Pacific Star de Occident (Mex) with

Pillsbury Co (The) on September 3, 1993 "agrees to acquire interest in". Aceros

Fortuna, S.A. de C.V (Mex) with Carpenter Technology Corporation on July 29,

34

1993 ·'agrced to acqu,re equity". Kennedy Agentes de Seguros (Me:-.:) with

Alexander & Alexander Services July 26, 1993 "acquired majority".

Novaquirn S.A. de C.V. (Mex) with Uniroyal Chernical Co on· July 26.

1993, joint venture. Brockman & Schuh (Mex) with Johnson & Higgins on J\fay 24.

1993 "agreed to acquire interest in". Arancia SA (Mex) with CPC International on

October 31, 1994 "joint venture". Altos Hornos de Mexico SA with Inland Steel

Industries Inc. October 17, 1994 joint venture. Auto Todo of Mexico with Genuine

Parts Co September 8, 1994 joint venture.

Grupo Iusacell SA (Mex) with Sprint Corp on July 26, 1994 "joint venture''.

Ispat Mexicana with Wheeling Pittsburgh Corp's steel, July 6, 1994 joint \·enture.

Grupo Video Visa (Mex) with Handleman Co on .Tune 2, 1994, "joint venture''.

Grupo Industrial Alfa SA de CV with Shaw Industries Inc. on May 31, 1994 "joint

venture".

Grupo Financiero Bancomer SA with NationsBank Corp.on April 15. 1994

"joint venture". FINSA Grupo Arguelles of Mexico with Morrison Knudsen Corp.

on March 1, 1994 "joint venture". Transportes de Nuevo Laredo, Mexico with

Roadway Services Inc June 1, 1993, "joint venture''.

Consorcio Larmo (Mex) with Durakon Industries Inc on March 23, 199 ··joint

venture". Grupo Industrial Durango with Temple-Inland Inc on January 6. 1993

"joint venture". El Puerto de Liverpool (Mex) with Kmart Corp on January 4. l 993

"joint venture" Compute with Acer on Jun 14, 1994 "joint venture".

Also important is the 50/50 merger between Holiday Inn Worldwide and

Grupo Situr in at least l O hotels Holiday Inn Express in Mexico.

Other firms that have made press announcements regarding interests in allying

with other national or international collaborators or competitors are (Marcela Ojeda

Castilla, .Tul 1993): Bimba. Celanese Mexicana. Cementos Mexicanos, Ceí\·eceria

35

Modelo, Cifra, Comercial Mexicana, Compania Industrial de Parras. Cydsa, Dina,

Femsa, Gigante, ICA.

Also important were Liverpool, Nacional de Drogas, Pemex, · Sigma

Alimentos, Situr, Spicer, Telmex, Televisa, Transportación Marítima Mexicana,

Tubos de Acero de México y Vitro, among others. Ojeda detected as a characteristic

in these firms before the alliance, the cost reduction and employment adjustments

policies.

Other interesting alliances that should be recalled are the one from Wall Street

Journal and the mexican newspaper El Norte, from Monterrey City to create another

communication instrument. Also important is the strategic alliance between

Multivisión and NBC to expand its operations in the Mexican market.

Alfa merged Desarrollo Inmobiliario Privado SA; Apasco to Industrial Apasco

SA de CV; Accel SA de CV to Grupo Chihuahua; Femsa, Fomento Económico

Mexicano to ali subsidiaries; GCarso to Corporación Ponder SA de CV; Ekco SA de

CV to Voit SA de CV; Ponderosa Industrial SA to Serponder; GF Inver Grupo

Financiero Inverméxico to Banco Mexicano Somex; Cifra SA de CV strategic

alliance with Wall Mart Stores; Grupo Embotelladoras Unidas (Geupec) to Pepsico

(Inscri pti on).

Ecko to Grupo Industrial Invasa SA de CV; Banacci, Grupo Financiero

Banamex Accival SA to Organizaciones Banamex; Grupo Situr SA de CV to

Astidek SA de CV; Valores de Monterrey SA to Fomento Proa SA de CV; Grupo

Financiero Serfin to Organizaciones Serfin; Empresas La Moderna SA to Desarrollo

Integral de Negocios SA de CV;

More recently, Ggemex Grupo Embotellador (Geupec) de Mexico with Grupo

Seser SA; Elektra to Grupo Empresarial Fenix SA; Elektra SA de CV to Silver Star

Exports Inc.; Empresas La Moderna to Asgrow Seed Co; MCI (US) joint venture

with Banamex in telephone services; Dillards Depanment Stores (US) joint venture

36

with Wall Mart and Cifra; GIE Corp (US) joint venturc with Gf Bancomcr; Indcrco

(USA) with Industrias Peñoles; Household Intcrnational (US) with Grupo

Financiero InverMexico, joint venture; Motorola (US) with Grupo Protexa.

Cementos Mexicanos (CEMEX) with Parker Lafarge (US); MotorCoach

merge with Consorcio G Grupo Dina SA de CV; Grupo Synkro agreed bid for

Kayser- Roth Corp (US); Asarco (US) acquire interest in Grupo México; Abaco

Casa de Bolsa agreed to acquire majority interest in Rodman & Renshaw Capital

(US).

Sorne other important compames that have experimented joint veoture or

agree to acquire interest in, are Compañia Industrial de Parras; Femsa with

CocaCola and Phillip Morris; Geo New York Life; Valves and Pipe Fitting;

Mobilcom; AXAs de Mexico; Cima de Mexico.

Ford Motor Company de Mexico; Electroforjados Nacionales SA de CV;

Grupo Iusacell with Bell Atlantic; Virmar Telecomunicaciones SA de CV; Pacifi

Star de Occidente; Aceros Fortuna SA de CV; Novaquim; Arancia SA; Grupo

Iusacell with Sprint Corp; Grupo Videovisa; Grupo Financieor Bancomer SA;

Finsa; Grupo Arguelles; Grupo Industrial Durango; El Puerto de Liverpool with

Kmart Corp (US) and Computec with Acer; among the most important ones.

Concentrations:

Up to December 1994, the Federal Competence Commission reported 86

alliances from which 34 were classified as concentrations, 18 administrative

restructurings and 34 participations in biddings for the desincorporation of public

companies. The FCC only established conditioning covenants in 5 of these alliances.

Among the most important cases regarding Mexican mergers, acquisitions and

alliances that the Federal Commision of Competence registered up to 1994 were:

37

Nolification Firms Kind of Complction Rcsolution

date Biddcrs and Targcts Stratcgic alliancc

D,1tc

l 9-jul-93 prornocion y fomento de acquisition of 06-ago-93 no objetada negocios.s.a.de c. v., sharcs

desarrollo integral de negocios s.a .. de c. v. y empresas la moderna. s.a. de C.V.

23-jul-93 grupo situr. s.a. de c.v. y turística acquisition of 2 l-scp-93 no objetada situr, s.a. de c.v. sharcs

03-ago-93 seguros la comercial. s.a. y seguros mergcr 06-scp-93 no objetada la comercial de chihuahua, s.a.

30-ago-93 grupo iusacell, s.a. de c.v. y bell acquisition of l 8-no,·-93 no objetada atlantic, inc. y otros sharcs

O l-sep-93 seguros america, s.a. y seguros la mcrgcr l 3-0ct-93 no objetada comercial, s.a.

l 5-sep-93 grupo financiero bancrecer, s.a. de acquisition of 29-oct-93 no objetada c.v. y banoro, s.a. sharcs

l 5-scp-93 grupo financiero cremi, s.a. de c.v. acquisition of 29-oct-93 no objetada carios cabal peniche y otros shares

2 l-sep-93 xabre, s.a. de c.v. y otros y consorcio acquisition of 12-nov-93 condicionada integral de empresas, s.a. de c. v. sharcs

27-sep-93 dese.sociedad de fomento industrial acquisition of O l-oct-93 no objetada s.a. de c.v., unik, s.a. de c.v. y spicer, shares

s.a. de c.v.

l 2-oct-93 constructoras ica, s.a. de c.v., ica merger 03-nov-93 no objetada servicios, s.a. de c.v., e industrias ica. s.a. de c.v.

25-oct-93 grupo financiero serfin, s.a. de c.v. y acquisition of l 5-no,·-93 no objetada

aseguradora insurgentes s.a. shares

25-oct-93 equipos de construccion e industria. merger l 5-nov-93 no objetada s.a. de c.v. y maquinaria, panamericana, s.a. de c.v.

28-oct-93 quan, s.a. de c.v. y grupo industrial acquisition of 12-nO\ -93 no objetada

bimbo, s.a. de c.v. shares

05-nov-93 vitrocrisa cristalería, s.a. de c.v. y merger l 2-nov-93 no objetada

vitrocrisa crimesa, s.a. de c.v.

1 O-nov-93 almacenes aurrera, s.a. de c.v. y merger l 9-nov-93 no objetada

operadora de superamas. s.a. de c.v.

l 9-nov-93 grupo televisa, s.a. y grupo t.v. merger 24-nov-93 no objetada

america, s.a. de c.v.

25-nov-93 grupo anahuac, s.a. de c. v. y cornccm. acquisition of O l-dic-93 no objetada shares

38

s.a. de c.v.

25-nov-93 procter and gambk de mexico, s.a. de acquisition or O l-dic-93 no objetada

c.v. y richardson-vicks. s.a. de c.v. shares

02-dic-93 grupo industrial durango, s.a. e.Je c.v. y acquisition oí 04-mar-94 no objetada

empaques de carton titan. s.a. shares

03-dic-93 corporacion industrial sigma, s.a. de transferencia de 05-ene-94 no objetada

c.v. y otras sociedades activos

5-c.Jic-93 consorcio g grupo dina. s.a. de C.V.)' merger l l-feb-94 no objetada

motor coach industries international

inc.

03-ene-94 grupo iusacell, s.a. de c.v. y domos acquisition of 25-mar-94 no objetada

corporacion s.a. de c.v. shares

06-ene-94 grupo embotellador de mexieo, s.a. de acquisition of l 4-íeb-94 no objetada c.v. y señores segovia serrano respecto shares de acciones de grupo seser, s.a. de c.v.

l l-ene-94 turismo cemex, s.a. de c.v. e acquisition of 28-ene-94 no objetada inmobiliaria cemex distrito federal. s.a. shares de C.V.

20-ene-94 compañia industrial de parras, s.a. de acquisition of 29-mar-94 condicionada c.v.,textiles karnel nacif, s.a. de c.v. e as sets inmuebles karnel, s.a. de c.v.

02-feb-94 vitro, s.a. y vitro coming, s.a. de c. v. acquisition of 04-mar-94 no objetada shares

03-feb-94 grupo financiero bancomer, s.a. de c.v. merger 04-mar-94 no objetada y subsidiarias

1 O-feb-94 panamerican beverages inc. e acquisition of 18-mar-94 no objetada inversiones azteca. s.a. de c.v. shares

l 7-feb-94 axa. s.a. de c.v. y sara lee co. acquisition of 04-mar-94 no objetada shares

l 7-feb-94 grupo bursatil mexicano, s.a. de c.v., acquisition of 07-abr-94 no objetada casa de bolsa. grupo financiero gbm shares atlantico y videoprima, s.a. de c.v.

l 8-feb-94 baja celular mexicana. s.a. de c.v., acquisition of 30-mar-94 condicionada tamcel. s.a. de c.v .. movitel del shares noroeste. s.a. de c.v., movicelular. s.a. de c.v. y moviserúcios. s.a. de c.v.

25-feb-94 grupo condumex. s.a. de c.v. acquisition of 19-may-94 condicionada conductores latincasa. s.a. de c.v. shares

28-feb-94 grupo financiero prime internacional, acquisition of 28-abr-94 no objetada s.a. de c. v.banco central shares hispanoamericano. s.a.

OI-mar-94 cifras.a. de c. v. y subsidiarias merger 24-mar-94 no objetada

I O-mar-94 valores monterrey. s.a. de c.v. y aetna acquisition of l 3-abr-94 no objetada international inc. ac fivc inc. actna shares internacional de rnc:xico. s.a. de c. v.

39

l 5-mar-94 grupo linanciero gmb atlantico, s.a. de acquisition or 20-may-94 110 objetada c.\'. y accionistas sharcs

18-mar-94 grupo financiero cremi, s.a. de c.v. y acquisition or 13.abr-94 no objetada banco union, s.a. shares

18-mar-94 ge lighting, s.a. de c.v.focos, s.a. y acquisition of 20-may-94 condicionada materiales de precision, s.a. de c.v. shares

22-mar-94 pedro domecq mexico, s.a. de c.v. y acquisition or 12-may-94 no objetada allied lyons europe, bv. shares

24-mar-94 preconcreto, s.a. de c.v. y concretos de acquisition or l 8-abr-94 no objetada alta resistencia. s.a. de c.v. shares

25-mar-94 agrobios. s.a. de c.v.univasa, s.a. de acquisition of 19-may-94 no objetada c.v. con agra holdings de mexico, s.a shares de C.V.

28-mar-94 corporacion industrial cycsa, s.a. de merger 3 l-may-94 no objetada c.v. fanal, s.a.

15-abr-94 concretos y precolados, s.a. de c.v. y merger 20-may-94 no objetada concretos guadalajara, s.a. de c.v.

1 O-may-94 controladora general motors, s.a. de acquisition of 31-may-94 no objetada c.v. y ca-le de tlaxcala, s.a. de c.v. shares

16-may-94 spicer. s.a. de c.v. y tremec s.a. de acquisition of 16-jun-94 no objetada c.v. shares

29-may-94 petroleas mexicanos y aeroservicios asset 16-jun-94 no objetada especializados, s.a. de c.v. transfer

Sourcc: federal Competence Commission

Reprivatizations of Former Public Firms.

Many mergers, acquisitions, consolidations and joint ventures emerged when

government privatized sorne of his firms. The Federal Competence Commission took care

that the privatization would not increase the monopolistic position of bidders. Following this

review of the Mexican evidences on strategic alliances a summarization of privatizations is

found by the FCC (in parenthesis appears the privatized firm).

Notification Firms participating in !he strategic alliances from privatization Completion Resolution

Date bidders / targets date

27-jul-93 radiotelevisora del centro, s.a. de c.v.(paquete de comunicaciones) 26-nov-93 no objetada

28-jul-93 grupo maicero mexicano, s.a. de c.v. (miconsa) 27-sep-93 no objetada

l 1-ago-93 santos, bimba del norte y archer daniels midland, co. (miconsa) 27-scp-93 no objetada

l 6-ago-93 cargill de mexico, s.a. de c.v. (miconsa) 29-sep-93 no objetada

l 8-ago-93 banca rromex. s.a. de c.v. (miconsa) 28-sep-93 no objetada

27-ago-93 agroindustrias integradas del norte. s.a. de c.v. (miconsa) 27-sep-93 no objetada

30-ago-93

JO-ago-93

30-ago-93

31-ago-93

l 9-oci-93

20-oct-93

27-oct-93

28-oct-93

29-oct-93

29-oct-93

29-oct-93

29-oct-93

29-oct-93

03-1101·-93

08-nov-93

l 9-nov-93

l 9-nov-93

l 9-nov-93

l 9-nov-93

l 9-nov-93

06-dic-93

08-dic-93

08-dic-93

09-mar-94

l 8-mar-94

04-abr-94

cstrat~gias y· plancacion avanzaJas. s.a. d~ c.v. (miconsa)

promotora empresarial de nccidentc. s.a. de c.1. (miconsa1

jugos del valle. s.a. de c.v. (miconsa)

lideicorniso molinero (lidemol) (mieonsa)

grupo tortimex. s.a. (miconsa)

tubaccro, s.a. Lle c.v. (procarsa)

lubcsa. s.a. Lle c.v. (procarsa)

lamina y placa de molllcrrey. s.a. de c.v. (procarsa)

industrias ch, s.a. de c.v. (procarsa)

productora potosina de papel. s.a. de c.v. (pronapade y otras papelería)

empresas asociadas l. y z., s.a. de c.v. (pronapade y otras)

organizacion editorial mexicana, s.a. de c.v. (pronapade y otras)

Jletchcr challcnge, ltd. (pronapade y otras)

potential industries, inc. (pronapade y otras)

ingeniería linanciera bancomcr. s.a. (pronapade y otras)

general de tubos y aceros. s.a. de c.v. (procarsa)

tic. ricardo humberto cavazos galvan y otros. (el nacionall

grupo mexicano de editores, s.a. de c.v. (el nacional)

corporativo am. s.a. de c.v. (el nacional)

luis f. gomez v. (el nacional unidad guanajuato.gto.)

luis capin flores y/o alejandro capdevielle llores y otros. \el nacional unidad hermosillo,son.)

efrain davalas padilla y otros (el nacional unidad guanajua10. gto.)

rolando andrade mendoza, ventura barajs aldapa y jase pastor carrillo (el nacional unidad hermosillo, son.)

víctor herrero otero, carios bustamante anchando y grupo bustamante ((el nacional unidad de tijuana, b.c.n.)

jorge villagomez, magdalena guevara ruiz y pe- dro gonzalez vidargas (unidad de tijuana b.c.n.)

infquim s.a de c.v.licitacion p/adquisicion de "ex- portadores asociados, s.a de c.v." (ocean garden products, inc.sierra refrigerating co.,compass transportation co.)

dr.william karam licitacion p/adquisicion de "ex- portadores asociados. s.a de c.v.''(ocean garden products.inc.;sierra refrigerating co.;compass transportation co.)

copamex industrias s.a. de c.v. (mexicana de papel periodi~o. s.a.

Source: federal Competence Comm.ission

40

29-sep-'J.l

27-scp-l)_, 11,1 nbje1ad,1

27-sep-l)J no nbjctaJa

27-sep-93 no objetada

29-sep-93 no objciaJa

24-nov-l)J cnnt.licion:ida

24-nov-93 no objetada

24-nov-93 no objetada

24-nov-93 no objetada

O l-dic-93 no objetada

Ol-dic-93 no objetada

O l-dic-93 no objetada

O l-dic-93 se retir0

O l-dic-93 se retiro

O l-dic-93 se retiro

24-nov-93 no objetada

l 7-dic-93 no objetada

l 7-dic-93 no objetada

l 7-dic-93 no objewda

17-dic-93 no objetada

l 7-dic-93 no objetada

l 7-dic-93 no objetada

l 7-dic-93 no objetada

l 7-dic-93 no objetada

l 7-dic-93 no objetada

l 9-abr-94 no objetada

22-abr-94 no objetada

I 9-may-94 no objetada

The Federal Commission imposed to sorne strategic alliances sanctions analyzed

case by case in a 27 days period to approve or to reject the merger, acquisition or

concentration. the principal ones were: Grupo Video Visa. S.A. de C.V. \Vith

41

Videoprima, S.A. de C.V.; Grupo Financiero Prime Internacional, S.A. de C.V. with

Banco Central Hispanoamericano, S.A.; Afin Grupo Financiero, S.A. de C.V. with

Banco Mercantil del Norte, S.A.; Corporación Noticias de México, S.A. dé C.V. with

Corporación Alvel, S.A. de C.V. Consorcio Integral de Empresas with Xafra S.A.

Sorne of these alliances were discussed in the FCC as sorne illegal

concentration was presumed. For instance, Consorcio Integral de Empresas acquired

94% of Xafra, controlling with this nine sugar locations and thus becoming the most

important sugar producer in the country, amounting 22% of the production and 49% of

the refined sugar. Compromises of substituting standard sugar for refined, besides the

cheapening of imported com would stimulate fructuose based corn. The merger was

approved.

Also, Grupo Iusacell with Telecomunicaciones del Golfo and others, was

discussed in the FCC. The reason the FCC gave in authorizing this alliance was that

although Grupo Iusacel increased its concentration in regions 3, 5 and 6, to reduce the

high market power of Telefonos de México, and also the regional competition between

the two companies. The merger between Iusacel and companies of regions 3, 5 and 6

were considered por competitive.

Other resolutions considered by the FCC that finally accepted the integration

between companies were:

Compañía Industrial de Parras, S.A. de C.V. con Textiles Kamel Nacif, S.A. de

C.V. e Inmuebles Kamel, S.A. de C.V., concentration in mezclilla production. no

impugned because the open market of this product in México.

Banco Unión and Grupo Financiero Cremi was accepted for the same reason as

in other banking cases, for existing other authorizations of new groups and new banks

in the country, as well as the increasing competition of foreign banks.

The insurance industry, for instance, Seguros La Comercial (third in the market) with

Seguros América (fifth in the market) was also accepted for the existence of 42

42

insurancc companies whcn the merger was authorized. With thc mcrger, the new firm

constitutcd the new lcader in the market, followed by Nacional Provincial and Seguros

Monterrey. For the same reasons given to the telephone industry, the mcrger was

completed without impediment.

Procarsa, SA de CV in 1993 was privatized. The licitation was won for

Industrias CH overcoming five competitors in the metal tu.bes production, Tubesa,

Tubacero. General Tubos, and Aceros SA de CV.

Grupo Condumex SA de CV acquired from Ericsson the 51. 7% of Conductores

Latincasa. With this acquisition Condumex would absorbe the 70% of !h~ sales of

telephonic cable. The acquisition was acepted as trade liberalization was taking place

stimulating imports of this product with a tax reduction of 13.5% to a rate of zero

percent in 9 years plus 6% of transport costs. As we can see in the precedent

paragraphs, many concentrations created mergers, acquisitions and strategic alliances.

Summarizing, the main causes for the acceleration of strategic alliances

seemed to be the Nafta agreement, the privatization process. and the financia!

globalization that brought more competitors as well as more investors in the

Mexican market. The financia! and economic conditions of the country acted as a

mood variable, stimulating or destimulating alliance proposals.

CHAPTERill

METHOOOLOGY

Five objectives have been followed when designing the methodology:

43

1.- To study stock price responses to merger announcements. being able ro

distinguish between firms with high abnonnal performance and firms

with mediurn or low abnormal pe1fo1mance.

2.- To determine the possible dete1minants of any abnormal pe1fonnance

detected during the merger announcements. That is. to estim,_ue if there

is any statistical association between abnormal returns and sorne

potential explanatory variables such as the size of the firms. accounting

perfonnance. growth expectations. previous stock undervaluation. and

signaling of managers 'efficiency.

3.-To forecast short run stock abno1mal performance for different kinds of

perf01mers, differentiating in high. medium and low performers and

finding sorne similarities and differences among them.

4.-To forecas the pcriod of time in which an expected merger event can

occur if the conditions encountered in the sample prevail.

5.- To infer which could be the causes motivating sorne kind of alliances.

i.e. to salve debt problems. to expand growth opponunities. to take

advantage of price disto11ions. or sorne other.

Hypotheses.

In this paper. the magnitude of the synergy is estimated using the stocks market

valuation of the acquiring firm. That is the target fitm's value creation is not included

in this research.

It is recognized it would be better to examine the combined value of the target

+ the acquiring finns returns. most of the Mexican firms were acquired in the 1989 -

44

1994 period did not have publicly traded shares. Therefore. this research provides

only a lower bond on the stock price effects of mergers.

This is important because sorne of the effects of the alliances benefit more to

the acquirer and sorne others to the target firms. 111is regards to policies with respect

to distribution of gains adopted during the control process, maximizing tax shields.

managerial and labor rights as well as other stakeholders righL'>. For instance sorne

wealth may be hidden for tax purposes and/or other obligations.

In this context the specific hypotheses in this research are:

Hl: Stock returns of merging firms in México have a _si~nificant

change as a result of strategic alliance announcements.

The first hypothesis tests for a direct relationship between merging and the

film' s stock p1ices. To reduce statistical noise and due to important macroeconomics

events. p1incipally the foreign cuITency devaluation or announcements different as

alliances, such as country debt problems or so forth, made us to select the May 1989

to September 1994 period. The tests would also have to control for other factors that

can affect stock p1ices. such as dividends or reprivatization announcements.

The first hypothesis is used to estimare what should be the expected increase in

the Mexican stocks compared to international experience. This latter has been

calculated in approximately an abnorrnal peiforrnance of 3 to 7% in a six days event

period, summing up both merger effects, the bidders and the askers effect.

To perform an abnormal return test for the days previous the announcement is

of great interese because of the insights for prívate information distorting the market.

A test on the volume is also included to determine if there was abnormal trading

associated with the merger announcement.

H2: The increase in returns is not due to the size of the firms but to

the value creation market signaling

The second hypothesis (H:J), tests whether the most important factors that could

be explaining the higher merger retums are most related with the synergy theory than

45

to anynther theory. This calls for evaluating synergy as an aggregated value uf excess

return over the tendency value and/or over the normal average market variation. Here.

we are interested in knowing the size. direction, and significance of the total synergy

creation occurring in a merger, such as manage1ial synergy, expenses reduction

(p1incipally labor cost<;) and/or dist1ibution of merger benefit'i.

H3: Significant differences exist between the firms doing alliances

and the ones not doing alliances. These differences account For

information asymmetry, synergy, and market signalling

H4: Significant postmerger returns exist across firms depending on

their financia! characteristics before doing the alliance.

The third hypothesis is for validation purposes regarding alliance effects. It is

designed as a face validity test and the fourth hypotheses looks to determine the

specific financia! and nonfinancial characte1istics of the firms that could explain why

sorne firms are expected to perform better in an alliance than others. as well as the

variables that could help to predict which classes of füms are expected to pe1fo1m

better if the characteristics and conditions of the sample remain.

HS: Stock prices of sorne of the acquiring firms increase more than

others due to sorne market undervaluation previous to the merger

announcement.

The fifth hypothesis. related to the undervaluation theory, seeks to differentiate

those firms that may have sorne undervaluation in their stock p1ices befare the

merger. Undervaluation is measured using a proxy of the Tobin's q ratio. in three

moments of the firms: a quarter before. a quarter during, and a qua1ter after the event.

A generalization is provided regarding the Tobin's q showed in the last year previous

to the merger announcement.

A test for undervaluation hypothesis is performed different from the one that

uses the Tobin's q ratio to measure the market valuation compared with the

46

replacement costs. In the Tobin's q ratio lower than I an undervaluation could be

happening. This ratio thus, assumes that the market works well in evaluating future

fim1 pe1tonnance so a difference with the book value could illustrate stock

opportuni ties. 1

The reason for not using the Tobin 's q ratio directly is that sorne researchers

alert that in Mexico exists a wider accounting criteria far actualizing the values of the

assets as compared to what the USGAAP recommends. Also. the higher volatility in

the Mexican stock values could mean less reliable valuation estimators.

Therefore, a similar test will be pe1formed based on an average cumulative

market to book values for the firms showing cumulative abnormal returns and

compared with what a random hold out sample gets.

This test would provide sorne funher evidence to the undervaluation theory that

states that stocks with lower market prices relative to their book values tend to

increase more during the merger events. not because higher synergy but because

higher premerger p1ice distonion.

H6: Inside trading existed in the Mexican merger experience

The sixth hypothesis attempts to give sorne evidence about the characte1istics of

the Mexican stock market during the 1989-1994 period. These characteristics are

related to market efficiency theo1ies. Tests to use will be based on desc1iptive

statistical analysis checking far normality and autocorrelation: press announcements

befare the official announcement; tests on cumulative abnormal return befare the

official announcement: tests on volume during the preannouncement pe1iod: and time

Dd"ining "q" ,tS the ratio of the market value of the firm shares to the replacement costs making auractiw to merge with

industries engaged in natural resources. i.e. sted. or in public services. a.s banking.

Tobin's q ratio = market value of rirm*

Replacement cost of a.ssdsH

,.. includl'S intangible ;'-"Sets

• ., physicd ,·,due oí ;Lssets

> 1 if potential Jeht

47

discriminating differences -significative- among clusters of firms and abnonnal

return.

Regarding inside info1mation examined usmg press news prev1ous to the

merger announcement, this will be complemented with the analysis of the specific

characteristics of the abnormal returns previous to the announcement and infomrntion

diffusion theories checking for institutional participation in the market..

Monopoly regulation in Mexico and the legal procedures that oblige finns to

infmm to investors about important corporate changes, such as mergers or sorne other

kinds of strategic alliances are therefore considered in the analysis

Also related with testing for inside information is a test for whether was any

info1mation manipulation, previous to the announcement. For instance, to test if

undervaluation of stock prices could be working in a negative direction to

stockholders (block stockholders relative to the public m general). This test 1s

performed by observing the behavior of the abnormal performance pnor to the

announcement compared with other countries abnormal pe1fo1mance prior to the

announcement.

Also, a discrimination of the results will be g1ven regarding the kind of

governance in the merging firms, i.e. if they are family governed or proffessional.

For instance, a decreasing abnormal pedormance before the announcement

could be related to a bigger volume so lowering prices abnormally. However, it is

expected that this test would be unsignificant in proffessional firms and significant in

family governed. For this latter, after the merger announcement, an increase in the

abnormal pe1tormance and a change in the direction of abnormal returns would be

expected. Can managers in a market with asymmet1ic information benefit from these

events or are the institutional investors such as the investment funds the ones who

realize this higher ponfolio perfo1mance? If this situation exists. considerations of

agency costs will be looked for.

::z: e::::,

< C....,.) ,:,___..)

e W.-.J

¡::..: ,::::= !:---e .....;;a

~ -.X:

~ -¡:e, __¡ ~ . p:.

..... -i.-

V~

"' C,"l

u (..._.)

e e:;, ~,::;i i..:.-i .~ ,.__

~ L.L..I

u. c::i

¡::..; :z: e::::

~ t_.l

~ ~ ¡......,

,=: i;...;

48

What the regulaLors do and whac are the benefits of this regulaLion is tesLed by

comparing abnormal performance in other events before and after the regulation used

to. Thus. resolutions from the Federal Competence Commission will be reviewed

looking for the regulatory procedures used for allying finns ..

Using also the Tobin, q ratio one can in fer if there were sorne imponant price

distonions before the official announcernents. The difficulty to know if the

accounting prices really reflect market opportunities gives space for asymmetric

inforrnation, in the sense chat managers knowing the valuation procedures can infer

more properly if the prices retlect or not the cornpany opponunities. Als~). a more

dubious reasoning raises: that the managers could be missignalling the market

intentionally.

To consider this possibi\icy. curnulative market value is prefeITed so. inscead

of che one mornent rneasurement. a dynamic measurernent will be applied. This is

performed by geornet1ically averaging the q ratio far the four previous quarters and

forwarding it in an cumulative index which is used as a predictor of abnorrnal retums.

lf the curnulative q ratio can explain sorne abnormal pe1i.ormance this test would give

sorne more evidence about the efficiency of the ~v1exican stock markec regarding

undervaluation of stocks. the efficiency of the accounting practices with respect to

asymmetric infonnation, and the value of info1mation to the rnarket.

Also to increase validity of che tests. it will be reviewed the consideration if the

Mexican market tends to overestirnate the relevant inforrnation -a kind of sentiment

cheory in opposition to the asyrnmetric inf01mation theory-. An investor can see

merger announcements as good news, over reacting to true value creation possibilities

ami chus increasing returns in che sho11 n.m but decreasing thern afterwards.

Managers of merging firms could be signaling to the market an strong interese

m solving sorne strategic problems or limitations in their firms or even more.

enhancing their growth opportunities and this new sicuation is "p1ized" by the markec

with a highcr return.

49

The previous situation seems to be consistent with the hypothesis that a merger

announcement signals information about the plans and the competitive advantage of

fi1ms so creating an environment where the investor tend sto over react in the sh011

run. as recent infonnation weighs more than past information or than the future

prospects of the companies.

The assumption that the one moment market to book value could be mislead but

not the average accumulative market to book value rests on the finding that in the

long run the stock prices tend to behave normally and consistently with the risk retum

models. This assumption is consistent to the market efficiency hypothesis.

For instance. from 1989 to 1994 the mergers' stock market returns included in

the sample increased 37% more than the risk free rate of interest and very similar to

the rate of increase in the book assets value. This supports our believe that the

cumulative market to book value may overcome temporal inconsistencies and

valuation practices or in market retums performance.

Sorne implications of this adjusted q measurement could change sorne

conclusions based on financia! multiples. For instance, regarding the valuation

practices utilized in the reprivatization prncesses based on book value multiples could

not be holding.

What is expected still be holding is that information provided in the merger

process signals infonnation that the firm is doing important strategic changes that

may create value. If riot why overperforming managers would do it? Of course, this

signalling has to be confronted with facts and consistent aftermerger announcements

days after the merger announcement.

Spurious market returns would be expected more in a overreacting market than

rn a market where expectations are built more rationally. Therefore, the signalling

hypothesis seems very appropriate to be performed for the Mexican case where there

is some belief that the Mexican market lacks of efficiency, so noise can be created

relatively easier than in a strong market, creating asymmetries and prívate gains.

50

Sorne irnpo11ant implications would be inferred for the accounting associations

with respect to their role in forcing companies to dis\'est the true securities ralue J.11d

their trne expected returns in their valuation practices. Their power in enforcing and

monitoring reliable information would claim to be improved.

Signalling of monopoly power in the Mexican mergers is really important in

explaining sorne possible oven-eaction of stock prices during a merger announcement.

This is so although merger regulation has been actualized recently to retlect more

accurately the current conditions of market power that not always can be benefiting

consumers and society. This is specially important after the Nafta agreep-lent took

place as the gains in the stocks of the merging füms more than creating value could

be decreasing value as competition is increasing in the rnarketplace.

For instance, Telmex was set to be a rnonopoly protected until 1996. without

lirnitation of profits, so prices were allowed to vary inrnediately the announcernent

was made and to adjust for inflation plus an initial prize.

The higher profitability that was planned to be gained up to 1997, through rate

rebalancing, special pricing for 1991 (situation that continued to 1993) caused sorne

protests from the industrial and commercial businessmen organizations. For this

considerations, the abnormal perfonnance tests will not include these finns

observations considering thern as outliers (however. these firrns are included in a

poste1ior test to allow for the presence of rnonoploy power that could be explaining

higher abnormal returns in the rnexican stock exchange).

With respect to the Banking systern, reprivatized in a worldwide record (one

and a half year) the similar can be said. After a period of successive merging of banks.

frorn 1982 to 1989 the number of Banks reduced from 60 to 18 via rnergers md

acquisitions. before the reprivatization took place. Why these concentrations \\'ere

allowed for the FCC will be explained relying this on higher foreign competition and

new Mexican banks corning soon.

51

Rep1ivatization produced 8.7 billion (17% of total domestic debt or 100% of

agricultura! GDP) The current market value of CAPS (the ce1tificates for capital

acceptances in banks) was set at less than 1/3 the Banking assets, while assets·

increased 1.4% and liabilities 2.5%. Branches just increased from 4438 to 4489 dueto

the rationalization of branch operations established since the end of 1985.

For these considerations similarly to Te1mex. reprivatization of the Banking

system is not included in the sample (For reviewing what happened with the abnormal

returns in the Mexican banking privatization see Santillan, Roberto. 1994).

Methodology explanation:

In this research the effect of the merger process on stock values of the acquiring

firn1s is estimated looking for significant jumps close to the merging announcement,

called day zero. This is known as the "event study method".

The first test using the event study methodology was done by Fama, Fisher,

Jensen. and Roll in the lntemational Economic Review, February 1969.

Event studies either (explicitly or implicitly) assume that markets are

info1mationally efficient or they explicitly test for the informational efficiency

(Starks, Laura 1993).

The announcement period is set at 60 days before the announcement. Toe "clean

period" covers from day -300 to day -60 for each firm included in the sample.

The measurement pe1iod in which the synergy hypothesis will be tested is set at 6

days before the announcement and 6 days afterwards.

Definition of synergy

Theory says that new opportunities are created in a merger to be accounted for

the target and acquiring firms creating a "combined" higher value than before

(Bradley, Desai. and Kim. 1982). The word "combined" underlines the sum of the

value of the merging firm to the value of the target firm. This sum compared on a

basis of before to after situation.

52

A synergy is said to appear in thc merger. accrumg to new demand.

tec:Jrnolugical innovations, and/or largcr investments by the bidding fírms. ami better

allocatiun of resources. managerial. customers. suppliers, distribution channels.

creditors. and so on.

The value creation in thc compames may result from more efficient

managemcnt. economies of scalc, improved prnduction techniques. the best

combination of complementary resources, the redeployment of a.~sets to more

profitable uses, the exploitation of market power, or any number of value-creating

mechanisms that fall under the general rub1ic of corporate synergy. At thjs moment

the possible causes are not explored with detail. This will be done when usmg a

multidiscriminant model looking for differences in abno1mal returns.

From Kim and Bradley (1988):

where:

and

dl! = dWT + dWA d/1 = total synergistic gain dWT=change in targetfinn shareholders wealth, dWA=change in acquiring-firm stockholders ivealth.

The model for estimating the predicted returns, is the market model. The reason for

this preference is that other altrnatives such as the tvIARM (calculated as the mean of

the daily return for the clean period) may overerestimate the tendency for the Mexican

market during the 1994 economic slowdown.

Model for calculating abnormal retums:

1.- From the Market Model:

Ri = a + bi Rm + e1

Which indicares that the cost of equity capital equals the risk free rate plus the

a\'erage market price of 1isk multiplied by the systematic risk measure. We Obtain the

abnormal returns in the market model. using the error te1m as J. proxy of the

une:,;,p\ained returns:

AR it = e1 = Rit - ai - hi R1111 error = Realiz.ed - estimared (a!mormal rerurn usi111,; 240 days (-300; -60)

n =+ó al1{/ : S ARit= SAR i = -ó

ARit = Almormal return tofirm ion day t (+) (-) ó day.\· SAR = Sum qf unexplained error.\' or ahnormal returns

accrued to the merging firms.for a sample of 40 merging firms; orde red arouncf the cfay (~{ rhe announcement ( day z.e m)

Rit = realized return tofirm i 011 cfay t a,b = estimated parameters using the MM for a long a1Ul clean period of

data (befare the merging process). Rmt = Realized return in the mexican stock index (11011-ec¡ually weig~tecf indexfor the event study period. lt is called market return

i = firm t = daily ohservations ar e/ose.

J ustification of the Model

53

Assuming multivariate normality (From Bradley and Kim, 1988) in order to be

able to constrnct sample tests and confidence intervals:

where: di! =dWT + dWA

dll=total synergistic gain dWT=change in targetfirm shareholders wealth, and dWA=change in acc¡uiring-firm stockholders, wedth. W = Market value of the combined equity on 6 days befare the merger, and 6 days afterwards, based on prívate offer date far interfirm i.

Wt = Market value of the targeted ec¡uity Market value of the acc¡uiring finn

= Wt * MSARt WA = dWt dWA = WA * MSA MSAR = Sum of the mean ofthe abnormal returns far a sampfe of

acquiring firmsfor the Mexican Stock lndex over an estimation pe riod ec¡uation qf 1989 to 1994 .

d = be comes far variation from unmerged "status ".firms to mergedfirms (when they merge).

This concludes that the total synergy effect of the mergers should include rhe

abnormal returns of the mergmg and the target fiims. However. as most firrns in

54

México during 1989 to 1994 went through consolidations and acquisitions of firms

not issuing at the BMV, the value of "d" calculated in this model considers only the

sum of the abnormal returns in the acquiring firms.

Empirical evidence has suggested that shareholders of target firms realize large

positive abn01mal returns in completed mergers. takeovers. leverage buyouts and

other kind of alliances. Although. in Consolidations. as the bidder and the target

become a more integrated firm. the separation of the gains makes no much sense.

Synergy could be realized in any of the two firms.

The explanation given to this empirical behavior rests on two facts: accounting

and assets pe1tect market assumption.

The accounting explanation says that the sum of the cash paid to the

shareholders of the target fiim equals the value of the acquired assets, thus value out

equals value in, making no sense that the value of the merging finn increase with the

merger.

The asset pertect market assumption says that no arbitrage could exist in the

merger acquisition as competition makes p1ices to reflect the trueir value. so

reinforcing the accounting explanation.

The researcher thinks that both hypotheses hold well in countries where strong

markets and infoimation behave pe1i.ect in a strong form. The absence of arbitrage

would be one of their characte1istics, as well as the asymmetry of infoimation

between the managers of the acquiling film. the investors community. and the

managers or shareholders of the acquired fiim.

This would create possible sources of impe1tections:

First. agency considerations between the managers and shareholders of the

target film. The hypothesis that the managers not always behave in the best

shareholders interests (Jensen. 1983: Asquith. 1983: Fama. 1984: and others) has

increased adepts without conclusive results. Asymmetry tend to vary regarding the

compllsition of the Board of Directors. the stock market regulation. the role of

55

blncklwldcrs. the generalized accounting practiccs ami the power n1' thc accountant

associations, and the monitoring that the market does to the managers work be trough

the efficiency of the managers labor markets and the intluence of bank credítors in the

monitoring of the fi1111s.

These considerations create no advantages for the rnerging firm realizables in

the stock market. But. what could be expected in developing countries where the

precedent assumptions can or can not hold, and thus. sorne arbitrage opportunities can

be created in a merging process.

Summarizing, three circumstances made us to select the kind of methodology

we dic.!: One. that most of the firms in official announcernents in Mexico du1ing 1989

to 1994 were Consolidations where the separation of the rnerging and the target firms

makes no sense: Two. that rnost of the acquired finns do not issue at the stock market

for being smaller or related to a holding fom that is already issuing at the B\lV: and

three. that sorne rnarket irnpertections are presurned to exist in the Mexican merging

expe1ience that can be creating arbitrage opportunities and infonnation asymmetries

that allows merging foms to take advantage of a lack of competitiveness in the assets

market as well as asymmetric info1mation.

This justificatinn does not denies the probability that sorne other gains are

created in the process. accruing to the target foms which are assumed to ha\'e been

m uch higher than the ones meas u red in this work. penaining to the acquiring firms.

Assumptions

Probably the main assumption in this work is that the Mexican market reacts to

the introduction of new information in a strong form. This does not mean that the

rnarket is assumed to be ped'ect in a strong fo1m as the size of the market. the low

number of issuers. and the importance of sorne of the issuers in signaling the market.

are cited for sorne weaknesses in the market. Although this is not the main ropic in

this work sorne considerations will be extracted frorn a theoretical and empi1ical

rCVIC\\.

The standard assumptions of the market modelare:

!.- The expected value of the error term is zero, E (e¡1)=0

2.- There is no homoscedasricit_v, Var(e¡1) is constam.

3.- There is no relationship between the error term and the return on rhe

marker, Cov( e¡1,R,,a)=0 4.- The error terms are nor serially correlated, Cov( eit,eit-1 )=0

5.- One firm 's error terms is not correlated with any otherfi.rm 's error term

Cov( e;1,ejt)=0 Slone l 993 II. A Brid Lilcralurc Survey.

56

The general functional relationships developed in the literature on mergers and

acquisitions are listed below according to the dependent variable and the é:;).Uthor who

discusses the relationship.

Discrimination between high versus medium and low pe1fo1mers.

This section describes the results of discriminant analysis for three quarters,

relative to the merger event, using direct method and prior probability equal to three

groups: 1 quarter before, the merger quarter, and 1 quarter after, which is the

discriminating variable and 4 predictor variables:

AR: average abnormal retum within each quarter LEY: total liabilities/total assets LIBR: (net worth/shares outstanding)/market price PU: stock price / stock earning FP: financia! performance T: time of the alliance as a proxy of the economic environment K: kind of alliance; i.e. if a merger, a consolidation, a joint venture. G: govemance of the firm; i.e. if family oriented orcapital disbursed S: Size of the firm measured as the actual value of total assets

Shon run pe1formance:

Subsamples of each group, high, medium, and low performers, will be gotten

and included in a multitime multidiscriminant model. The long run period of time will

be selected for fürns with no more imponant events after the initial merger

announcement and testing for significant differences across groups and across time.

57

Higher validity for synergy hypothesis is expected if the firms continue

becoming more alike ( they keep in the same discriminant group) or they change if

other significant events occur. If the tirms become more similar as mergers occurs,

their similarities would signal manage1ial intention of continuous pe1fo1111ance.

From this, one could infer that managers relying more on corporate

restructu1ing strategies" such as a merger tend to take more value creating strategies,

though 1iskier. Accounting for differences reduction through time among merger and

non merger foms would imply that merger is irrelevant in the sh01t rnn.

In this research we are proposing to measure the short time effe~ts of the

merging process on stock values of the acquiring and not on the target firms, looking

for a notable jump around the merging announcement, called day zero. This is known

as the "event study method" (Martin, J.1993).

A census of merger firms issuing at the Mexican stock exchange is gotten from

the board of directors bulletins that merger firms are obligued to communicate to the

public. From this census a sample of firms is taken for the period of 1989 to 1994.

The announcement period is set at 60 days before the announcement, though the

measurernent period in which the synergy hypothesis will be tested is set at 6 days

before the announcement and 6 days afterwards. The hypotheses are comparing the

abnormal returns in the announcement period with the behavior of the stocks during

the so called "clean period" (the one in which the related enterprises neither think in

merging nor in complementing assets or projects).

The "clean or estimation period" covers from day -300 to day -60 for each

film included in the sample. The estimation period is established at 300 days, ending

60 days before the announcement. consistently with other similar studies across

countries.

This estimated value is deducted from the real values observed for the merging

fim1s during the announcement period which in this research is set in 12 days around

the otficial day. The difference between the estimated value and the real value (called

58

residual term) is a proxy of the abnormal retums due to the merging. The sum of the

errors or the abnonnal returns. would give an overall measure nf the merging synergy

effects on target and acquiring tirms during a period called event period wl"Íich in this

case we said is 6 days before the announcement and 6 days afterwards.

Thintrading.

Nonsynchroneity or when secu1ities are thinly traded, ordina1'y least squares

regression may result in biased beta estimators due to the correlation between the

thinly-traded secmity's retum at time t and the index retum at time t-1 (Starks. Laura.

1993). Sorne techniques have been developed to mitigate this bias by usiq.g Jeading

and lagging values of the index market model (Scholes and Williams. JFE, 1977 or

Fowler and Rorke, 1983). These techniques will be applied to the mexican merger

sample as the following thintrading has been detected in the period of 1989-1994 for

8 out of 40 stocks with thin trading:

Subsample of Thin trading

mergt!r stocks

Thintrading in Mexican Merging firms

# of trading days # of non trading days thin trading index

205 55 .067

A Discriminant Model will be used to test for differences between two or more

groups of cases. These "groups" are defined looking for diferences in the pe1i'o1mance

of the firms during and after the announcement is made.

This helps to answer the question if there exist sorne circumstances previous to

the event that may be explaining sorne possible after merger returns obtained during

the days of the announcement, and to see if these differences continue after the

announcement or they changed significantly compared with the previous firms

characteristics.

59

This could explain different after merging perfonnance in terms of sorne

predefined variables. In this research is intended to distinguish the fi1111 's financia!

situation relative to the merge event, one trimester befare, during and one after.

To distinguish between the groups, the researcher selects a collection of

clisc:riminatin¡; variables that measure the characteristics on wich the groups are

expected to differ. In this case is supossed that the financia! situation is affected by

the merger event and. if so, how much and in what direction for every group.

The mathematical objective of this discriminant analysis is to weight and

linearly combine the discriminant variables in sorne fashion that the groups ~re forced

to be as statistically distinct as possible. Discriminant analysis attempts to do this by

fo1ming one or more linear combination of the discriminant variables. These

··ctiscriminant functions" are of the form:

O¡ = d¡1Z1 + d¡2Z2 + ... + d¡pZµ

Where O¡ is the score on discriminant function i, the d' s are the weighting

coefficients, and the Z' s are the standardized values of the p discriminant variables

used in the analysis. The maximum number of functions which can be derived is

either one minus the number of groups or equal to the number of disc1iminant

variables, if there are more groups than variables. Ideally, the discriminant seores

(D' s) for the cases within a pa11icular group will be fairly similar.

The discriminant functions can be thought of as the axes of a geomet1ic space,

they can be used to study the spatial relationships among the groups. The weighting

coefficients can be interpreted much as in multiple regression or factor analysis. In

this respect. they serve to identify .the variables which contribute most to

differentiation along the respective dimensions (functions).

Once a set of variables is found to provides satisfactory discrimination power

for objects with known group memberships, a set of classification functions is de1ived

to pe1mit the classification of new objects with unknown memberships.

60

In this investigation. membership allows to c.listinguish between gnnc.l

performers. regular anc.l bac.l pe1formers. This membership is tested before. c.luring anc.l

after the merger event.

The importance of the number of groups stems from basic principies. In general.

twn points in space define a line. three define aplane. four define a three-dimensinnal

space. etc: the maximum number of dimensions needed to completely describe a set

of points is eme minus the number of points.

In disc1iminant analysis, each group (as measured by its centroid) is treated as a

point and each discriminant function is treated as a unique (orthogonal) djmension

desc1ibing the location of that group relative to the others. Two functions maybe quite

adequate for describing four groups. as is the case in this research. the first two

functions explain (uncommonly) 100% of the va1iance.

There are two measures for judging the importance of the discriminant

functions. One of these is the relative percentage of the eigenvalue associated with

the function. The eigenvalue is a special measure computed in the process of deriving

the discriminant functions. It is a measure of the relative import,mce of the function.

The sum of the eigenvalues is a measure of the total variance existing in the

disc1iminating variables.

A further aid in judging the importance of the disc1iminant function will be its

associated canonical correlation. The canonical correlation is a measure of association

between the single discriminant function and the set of (g - 1) dummy variables which

define the g group memberships, in this case gis the -1, O, 1 quaners relative to the

merge event. It will tells us how closely the function and the "group va1iable" will be

relatec.l i.e. which is a measure of the function' s ability to discriminare among the

grnups. If we reverse the logic somewhat. we can interpret the canonical correlation

sc¡uared as the proportion of vaiiance in the discriminant function explained by the

groups.

61

Lambda is an inverse measure of the discriminating power in the llriginal

variables which has not yet been removed by the discriminant functions-the larger

lambda is. the less info1mation remaining. Lambda can be transformed into a chi­

square statistic for an easy test of statistical significance.

The discriminant function coefficients have to be de1ived in such a way that the

disc1iminant seores produced are in standard form. There will be a separare score for

each film in each function. This single score represents the number of standard

deviations each firm is away from the mean for all cases on the given discriminant

function. The means on all the functions are refeITed to as the group cenrroid..

A comparison of the group means on each function tells us how far apart the

groups are along that dimension. With this, we can get differences between the groups

as well as differences among the groups.

lf this procedure is repeated trough time. you can get differences bet\\'een and

among groups through time, so you can test for long run differences and see if an

event. in this case a merger event gives a higher differentiation between or among the

groups or not.

This difference is said to be explaining different abn01mal or extraordinary

performance to an event announcement, short and long run. However. this thesis only

tests for sho1t run differences leaving the long run differences for a posterior research

that can give more signaling for managers doing a correct job in creating value or not.

The standardized discriminant function coefficients are of great analytic

importance in interpreting the differences between and among groups. When the sign

is ignored. each coefficient represents the relative contribution of its associated

variable to that function.

The sign merely denotes whether the variable is making a positive or negative

contribution. The interpretation is analogous to the interpretation of beta weights in

multiple regression. As in factor analysis. these coeffcients can be used to ··name" the

functions by identifying the dominant characteristics they measure.

62

The classification of cases or objects is meant as the process of identifying the

likelyhood of each group membership when the only information known is "z" value

on the discriminating variables. Thus, instead of classifying the firms ex ante far size

or another variable, one let'i Statistics to speak of everyone's differences.

As far as one divides the total sample and one works with half the sample for

estimating the discriminant functions, one uses the other half of the sample for

validation purposes. Classifying the objects to derive the functions in the former

sample and comparing predicted group memberships with actual group membership,

in the latter, one can empirically measure the success in discriminating the groups by

observing the proportion of correct classifications.

Statistical tests on the Market Model.

For the Market Model conventional regression tests will be utilized to evaluare

the significance of the alpha and beta estimators. R-squared tests will be performed 011

each firm market model, as an overall reliability of each returns predictor model,

using the F-distribution tests. On each estimator, as well as on the sum of errors. or

abnormal retums, the "t" test seems appropriate following similar investigations in

which statistical validation is perfo1med.

Testing significance in abnormal returns

Null hypothesis:

The hypotesis of no reaction in abnormal returns to a merger

announcement is foimulated and has to be tested.

Altemative hypothesis:

The event is presumed to be relevant to the returns of the

merger fiims compared with the precedent values under

consideration. Thus, the event is presumed to have either a

positive ora negative effect on returns of the merging firms.

63

As there was no prev10us study with respect to merger effects, a one-tailed

versus two-tailed test was prefered. This allows for the returns during the event to be

positive or negative, implying a two-tailed test.

A "t" test statistic for abnormal returns was pert'ormed as the merger events

under analysis are assumed to happen in a cross-sectional independence i.e. the events

happen at different times for different firrns. Also assumes the error term follows a

stationary n01mal process. Comparison periods return t statistic (From Mausulis, JFE

1980. Taken from Starks, Laura, 1993).

Testing Ho : CAR (-4, +8 ) = O

"t"-statistic= CAR (-4. +8 )

S car(-4. +8) /1/, n

OLS market model t stastistic

t= CAAR(tl,t2)!{ 2.,Var (CAAR(tl,t2))]112

where Var (CAAR(TJ,12))=Variance of estimation period AR.

Ano1her "t" test that couúl be performed is:

t=AR,/{[Trl )s12+(Trl )s/ ]l[T1+Tr2J)112 *{ l/T1+1/T2}m

where:

T1=#of daily returns in comparison (estimation) period

T2=# of daily returns in announcement (test) period

s1=standard devia1ion of comparison period mean retum

s2=standard deviation of announcement period mean retum

Note that this statitics assumes that the true standard deviations of the

comparison and announcements periods are equal.

Autocorrelation of en-ors in the merging period is expected, although not during

the clean period. this is very important because it can come about the presence of

om i tted variables that are associated with target and/or acquiring stocks altogether: for

instance tax obligations.

U'+

Positive correlation i.s expected during the merger pe1iod because of fast

spreading of infonnation. Durbin-Wat.son tests will be useful to test for correlation

problem when thi.s be necessary. Partial correlations tests will also be used to estímate

the magnitude of the autocorrelation.

A Ruback' s Technique is utilized for adjusting for first-order autocorrelation in

abnormal retums (Ruback JFE 1982).

Variance of CAAR (t 1,t2) =T*var (AAR,)+ 2(T-J )cov (MR,,AAR,.,)

where T= 72-Tl +/

M=number of days during the estimation period

Avg(AAR,)=[IIM] .L,AARt

Var (AAR1)=[ 1/M] .Lr [AAR,-Avg (AAR,)]2

Cov(AAR1,AAR1+;)=[ 1/MJ .L r [AAR1-Avg(AAR,)J[AAR1+1 -Avg(AAR,)]

Toe variance and the first-order autocovariance of abnonnalreturns are estimated

over thc estimation period.

Test on size effect.

Size is a variable that could be associated with the error tenn so creating sorne

correlation disturbances. A test based on dummy variables seemed to be able to give

us .some insights on this problem.

The market model can be rewritten to allow for a dummy variable which

switche.s "on" during the time peri.ad of interest (Starks, Laura. 1993). For example,

with the market model :

AR = R¡1 - ( a¡+ ¡Rm1+W¡1 Eventit)

where Event¡1 is one during the relevant time period and zero otherwise and

corresponds to size o the füms measured by total asset.s in constant terms of 1994.

The test is performed with quarterly dummies-one for the quarter in the test

period). Tests based on the coefficient W¡ are equivalent to a test on the estimated

error terms in the rnarket line equation. Thus. the W¡ give information about the sign

65

and Lile magnitude of Lhe firm's response to the event ar date t, -6, +6 arnund e.lay O.

A very interesting procedure that can be used for testing the distribution of

wealth theory, may be a test for efficiency of the estimators near the merging

announcement. Hypotheses are made of non-constant and unequal variance in the

rnerging period and dummy variables for controlling sorne other exogenous factors

that may be intluencing the process, such as undervaluation of assets, technology

creation, government protection and monopoly power. It is expected that the

estimators for these variables be non significant in the merger announcement _pe1iod.

This test is based on the measurement of the va1iance of the estirnators in the

clean period compared to the event period, and constructing a X-squared test for

these variance differences to test for reliable differences.

Looking for non constant vaiiations of disturbances over time, and instead. a

heteroscedastic behavior is looked dming the merging period. This increases

significantly the size of the variance offering new supporting data (statistical

significance) that, during the merging process, the stock market loase randomity and

instead, it enlights information and signaling that new expectations are boming, so

variance increases correlated trough time.

Industry effects.

Similar considerations as with the size effect are raised with respect to industry

effects. These could exist if during the event period the industry, not the merger film

itself observed abnormal returns due to growth announcements, protection, regulation

or other factors affeting the same to every firm in the industry.

Grinold. Rudd and Stefek study (1989) give techniques dealing with this

situation. These rest on calculating excess returns (in local cuITency) as a function of

local market return industry retums (BMV classifications). Common factor returns are

normalized by industry residual retum. What is expected is that the proportion of the

variance of quanerly returns explained by local market plus industry factors give

66

higher explained vanance without lowering the t statistical significance llf market

returns as a predictor of merging firm returns.

Also. the "simulation sample" as it is replicating the same industrial sectórs as the

merging sample allows us to distinguish the imponance of the industry effect.

Industry and Firm Concentration

Heiiindahl Iñdex of Concentration for sector j, firms y:

Hi = I ¡(w¡j)2

where wij == the market value proponion to sector j 's index represented by stocks in

indusuy y with respect to the gross domestic product of the respective seqor. These

Herfindahl indexes are calculated by the Federal Competence Commision (Comisión

Ferderal de Competencia or FCC) and are used to asses if they could be explaining

abnormal rerums dming the merger event.

For instance, Roll ( 1987) ran a regression of the monthly standard deviation of

the index returns against several concentration measures. He found that more

concentrated stock markets, whether concentration is measured either by the

Herfindahl index or by the number of constituent stocks, display higher retums.

Funher he fcmnd that the results using the Herfindahl concentration index were more

significant than the results using the number of stocks as a concentration measure.

Therefore. t-statistics will be used to measure the significance of the various

indusuies characteristics in explaining abno1mal returns. A high t indicating the

higher relative importance of that industry to the total index . The size of the "t"

statistics also indicate the degree of ahigher importance of the industry concentration

to abnormal returns explanation. More over, remember that fiITils that were enjoying

of high monopoly power such as Telmex were not considered neither in the merger

sample nor in the simulated sample ..

A double face validity test is included in this research to deal with problems of

overestimation of abnormal returns in small samples as well as some problems that

emerge from thin trading.

67

Data.

Fi1111s alliances sample:

A sample of 40 füms was taken from the l 989-1994 period where accounting

infonnation was available one year befare and six months after the official merger

announcement was made. The official date is taken as the Bulletin of the Board of

Stockholders registers for each firm as there is no an electronic database for merger

events.

Stock pnces are taken from Indet database, electronic archiva! from the

Mexican Brokerage Warehouse using daily prices for the stocks selected in the

bulletin research coITesponding to -300 days befare the announcement and 60 days

after the event..

Financia! statements were taken also from the Mexican Brokerage Warehouse

and completed when necessary with electronic supply of data from Dow Iones.

Economatica and information gathered by the Center for Computational Finance

using real time requests to suppliers of infonnation.

Prices provided by Indet database already are adjusted by splitts and dividends.

The market model was built using the unequally weighted IPC as other researchs have

found high consistencies with other specialized equally weighted indexes such as the

INMEX for the banking institutions.

Ali the information was worked m SPSS statistical package. principally the

discriminant model where bigger data manipulation is required.

Archiva! research based on Infosel database was pe1fo1med to review the press

information on strategic alliances and merger news.

Reports from the Competence Comission were also consulted looking for sorne

more alliance or mer2:er announcements. as well as documentin2: the re2:ulation ~ ~ ~

regarding merger or allying authorizations. The similar search was done for the

banking system where the repons of the Comisión Nacional Bancaria y de Valores

68

was consulted to get information about the authorizations regarding banks and

brokerage warehouses.

Holdout sample.

A sample of 40 firms was replicated randomly within the same industrial groups

as the true merger finns and same event dates were simulated for these firms

replicating the true event announcements in the merger sample. To this sampk the

name of "simulattd merger sample" was refered.

The "simulated merger sample" was built to peri'orm validity tests on µbno1mal

returns and on standard deviations of expected returns. A desc1iptive statistical

analysis was pe1forrned looking for consistencies in their distributions during the

clean period and differences in the estimation period.

Similar analysis was pe1fo1med regarding the multidiscriminant analysis of the

abnormal returns of the merger firms compared with the ones obtained by the

"simulated merger füms".

As the methodology states. descriptive statistics were performed where

differences and simila1ities between the "simulated merger sample" and the true

mergers sample were analyzed.

Also the true merger sample was divided into two subsamples. These were

called the "analysis sample" and the "holdout sample" for testing the discriminatory

power of the multidiscriminant model.

Specific characteristics of the foms included in the merger sample were

summmized in Annex 1. The results are presented in Chapter V.

Sorne researchers assess the likelihood that a methodology lead to a Type I e1rnr

-rejecting the null hypothesis of no abn01mal retums when is true. and a Type Il e1rnr

- failing to reject the null hypothesis of no abno1mal pe1fo1mance when is false-. The

important issue is. thus, the power of the vaiious methodologies. Power is the

probability. for a g1ven leve! of Type II error and a g1ven leve! of abnonnal

69

performance, that the hypothesis of no abnormal pe1fonrnmce be rejecteu enoneously.

Test's power indicares a stronger presence of abnormal performance. thus

keeping constant ali other things. a more powerful test would be preferred.

There are severa! peculiarities to increase the test power. For instance.

secu1ities should not, on average. exhibit any abnormal pe1torn1ance previous to the

eventannouncement

CHAPTERIV

EMPIRICAL EVIDENCE REVIEW

70

Most studies on mergers. acquisitions. spinoffs. leverage buyouts. and

takeovers. deal with the estimation of the merger effect nn the finn \·alue. Most uf

thern have based their methodological elaborations on the concept of abnn1111al or

extraordinary retums while sorne others have based their reasonings on path models.

sirnulation models and more recently, clinical studies (PaITino. Roben. 1995). These

other methods use complex mathematical algorithms. event simulations. and/or real

time neural models and expen systems running out the merger effects on film value.

Event studies base their analysis on a direct arrangement of data around day

zero. graphing the observations and taking averages on 5 to 10 days around the e\'ent

date. Event study methods help to measure the impact of specific types of finn

decisions on the financia! or organizational results of the firm or other related finns.

In most investigations. stock returns are employed to measure security price

performance, as a proxy of the results caused by the event or its announcement. This

suggests at least two important things: that the security price performance represents

the trne expected return in a firrn -as investors compare it with sorne other assets- and

that the event can be isolated as a direct cause to measure the stock p1ice variations.

Most studies use the :\larket Model under a wide variety of conditions. This

model is refered to as one valuation model that adjusts prices for risk. Sorne other

researchers, use simpler methods which do not explicitly adjust for market\\'ide

factors or for risk performance. However. as seen in the empírica! review. these

simpler models can estímate expected retums no much worse than the market model

(Brnwn Stephen J. April 1980 l.

The rnain objective in e\'ent studies has been to estímate the size and direcrion

to \\'hich security price -or sorne other variable- vaiies as a result of an announcement.

Tht' irnponant issue when usrng these mndels is to dete1mine if this abnom1al

71

beha,·ior comes from the announcement llf that event or from other simultaneous

causes. In other words. to be able to decide to sorne extent if abnonnal security

performance is differ'ent from that which woulc.l have been occurred in absc-ence of the

event.

Researchers utilizing this methoc.lology accepted severa! implications. Fm

instance. a direct relationship between the selected finn p1ices and the market prices

under efficient market behavior. Sorne other assumptions regarding the behavior of

retums. are time coITelation, expected va1iance, and so on. The following paragraphs

shmv how some other studies have dealt with these considerations and what have they

founc.l regarding important alliance events.

Systemathic non-zero abnormal secu1ity returns after a particular event would

be inconsistent with the hypotesis that security prices pe1formance adjust quickly to

reflect new infonnation as perfect markets assumes. The event is or must be

unanticipaded, thus, the magnitud of abnormal performance at the time of the event is

a measure of the impact of that type of event on stockholders claims. More

specifically, abnormal pe1fonnance is consistent with market efficiency as

info1mation is diffusing consistently in the market.

In most papers. observed stock returns -and not stock prices- are employed to

examine various methodologies which are based on event study method to measure

secmity p1ice pedormance.

Jensen and Ruback (1983) reviewed 13 studies of mergers in the 70's

obtaining a 20 percent increase in target stocks and mixed results on bic.lders. They

were able to differentiate the stock effects if the mergers succeed compared to the

retums showed when the alliance does not succeed. Success is determinec.1 there when

the announcement really ends with the merger. without reversa!. Surp1isely. he found

in unsuccessful mergers a 30 percent loss in returns of targets and more than !Oo/c loss

in bic.lc.lers. Moreover. significant decreases accornpany long periods of successive

price falls following unsuccesful rnergers.

72

Wliat makes bidlkrs to gain abnonnal returns if the merger succeed but to losse

if they do not remained merged? This for some authors is controversia!.

Jarrell. Biickle\·. and Netter ( 1988) surnrnarized results for 6.63 tender offers

from 1962 to l 985. obtaining an average of 30 % increase in target stocks on 1980-

1985 mergers. They found 3.5% gains in bidders. with low significance.

Bradley. Desai and Kim (1988) found a 35 C/c increase for a sarnple of 721

mergers occurring dllling 1981-1984. They studied the combined effects of the

mergers on the bidders and on the targets and they tested for the combined effect

instead of the effect on each separately. Using the market modeL they fo~md 3.2C/c

abnorrnal returns around the announcement period.

In rnost studies. the extraordinary increase 111 target returns contrnls for

accounting practices. related regulation when the e\'ents occur. businesses practices

and the adopted strategy for the forthcoming months.

Different results emerge in the event studies depending on the circumstances

in which the alliance occur. or the kind of the alliance. For instance. compared to

acquiring füms' behaúor. target firms develop legal defenses to protect against

stakeholders' rights. so becoming better positioned for own investors and thus.

creating a different stock behavior.

Bidders are found in most of the empirical evidences as the emes who obtain a

higher positive abnonnal return. Jensen. Brickley, Bradley, Netter. Roll. and Wasley

(1983) found negative or very low but "not significant" retums to acquüing firms. and

positive less than !SS~ "significant" returns to bidders on average.

Sorne other tests on the mean returns applied to target and acquiring firms show

patterns that suppon the theory that both firms gain from the merger. but legisbtion.

principally tax legislation. favors more the acquired. so it becomes more profitable to

benefit financially and L)rganizationally (though acquiring film managers benefit the

mnst).

73

The synergy hypothesis is tested in Kirn. Bradley. Desai ( 1979); Rol l. Eckbo.

Stillman ( 1982). They found combined returns higher than the simple added average

for the clean period. set by most of them at more than 90 days béfore the

announcement. For these authors. increased market power and organizational

complementarity between the two organizations were the most important factors in

explaining synergy creation and the size of this synergy.

Consistent with this. a study examined the effects of mechanisrns commonly

used in the various event periods of a merger or acquisition (Smith, Virgil Orin.

1994). This author looked for knowing if sorne mechanisms that are availa_ble for a

bidding firm. are more effective than others in bringing about a merger and sustaining

it. Also. he looked if there exist sorne integration mechanisms that are more effective

than others in preventing an early dissolution of the alliance. Toe mechanisms

exarnined were those based on cooperative interpersonal relations between the top

managernent teams of the original two entities, and those which rely upon coercive

influences.

To examine these questions, Virgil Smith, took a sample of 213 merger

attempts, and 83 cornpleted mergers. He applied an analysis of secondary textual

sources. He concluded that the chances of successfully completing the merger, and of

creating a merger that does not end in early divestiture, are related to the mechanisms

used. Smith concluded hat coercive mechanisms existent in the market for corporate

control. are not as effective as mechanisms based on interpersonal relationships

between the top management teams of the two firms (Smith, Virgil Orin. 1994).

Sorne other researchers have found a different but consistent evidence. For

instance, Dennis and McConnell (1986) found positive correlation between buyer and

seller returns. accruing to synergy theory most of the results. They also found a

positive increasing serial coITelation approaching the announcernent day between

both kind of füms rejecting the null hypothesis of zero abnormal returns during the

event.

74

Den nis and McConnell based his study on a sample period of l 9ú2-i'\O and an

event period of -15 to + 12. They found no abnonnal returns neither for the acc.¡uiring

firms nor for the bidders. This result is also reponed in other studies. so cÍ·itizising the

abnormal returns method and refering itas a paI1 of the specification error.

Cook and Martín did found abno1mal returns in a 1970-86 sarnple although

negative, studying 63 firrns in an event period of -24, to +25. The average abnornrnl

retum far the event period was found to be egua! to -1.21 %. This result was probably

sorne noise in the highest strata of the sarnple (firms with leverage greater than 50% ).

For that part of the sample regarding firms with 25% lower leverage. the_ cumulative

abnorrnal return resulted in 4.84% (Martin,J. 1993).

Mergers and leverage buyouts in event studies seem to account more for

abnormal retums than any other kind of strategic alliances. They have concluded that

hypotheses based on transfer of wealth were not explaining the higher stocks

variations. For instance. Lehn and Poulsen (1987), Travlos and Millon (1987);

Marais, Schipper and Smith (1989). Martín and Cook (in Martin, 1993), and Warga

and Welsh (1989). Ali of them found negative cumulative abnormal returns in the

bidding returns, low significant.

Neither Managerialism theory nor Monopolist or Concentration - Collusion

theúries have been found significant in explaining abnonnal returns. Sorne

explanations to why this occurrs are refered to rivals reactions what create

simultaneity problems in the testing procedure. Contrarily, Undervaluation theory has

been \'ery successful in explaining value creation in natural resources kind of mergers.

but not in others.

Tax Advantage. Managerial Compatibility, as well as Labor Savings theories

ha\'e been found significant though accompanied by other impo1tant moderator

variables that help to explain the wealth creation process near the merging dates.

Sorne nf these moderator variables are: market share, redistribution of benefits. and

sorne llubris processes.

75

Adjusting for marketwide factors explaining stock reaction. Brown ( 1983)

examined severa! altematives. These included a one-factor market model for

abnnrmal retums: a two-factor model utilizing Fama-MacBeth residuaís. and a

control portfolio technique in which the return on a ponfolio of sample securities was

compared to that of another portfolio with the same estimated systematic risk.

lnclusion of iITelevant vaiables or omission of relevant ones when estimating

retums, seerns to be two of the most important problems in explaining abno1mal

returns. Also, the problem of heterogenous samples rnakes difficult to generalize the

results to other alliances (externa! validity).

According to the free cash flow theory proposed by Jensen (1986). excess cash

available to bidders may be able to explain the motives of mergers and the market's

reaction at the announcement of an acquisition. As we saw in the first pan of this

paper, Free Cash Flow theory proposes that firms who have excess cash and who do

not distribute it to their shareholders. tend to expend their rnoney on acquisitions

which are rnostly low or negative pe1i"01mers. This creates an opportunity for higher

returns in the bidder füms.

Rahim Niazm study (1983) analyzed the reactions on the stock p1ices of the

bidding firms around the announcement day by stratifying the samples depending

their method of financing, type of merger. and the leve! of free cash. He hound

significant abnorrnal retums when cash flow was significant and the füms seemed not

having problems in financing.

However, other empüical evidence show that stockholders of bidding firms lose

when leveraged mergers are announced even if the bidders had high cash flow. Lower

abnormal retums are gotten when leverage is higher than when it is not.

Sankaran. Kizhekepat ( 1993) did a study to show that firm pe1fo1mance during

the merger announcement depend upon the leve! of synergy pursued by the film:

Regarding performance differences across diversification archetypes. the results

76

suggested the need to pursue innovative strategic alliances that cal! ror the highest

complementarity among the bidder and the target finns.

Other common hypotheses in most studies include agency/governance.

managerial characteristics and resource availability. Operating performance and total

diversification are taken as control va1iables. Logistic regressions and path analysis

techniques are some of the most employed techniques to evaluare the data. In addition

to performance and diversification. other significant predictors have been ownership

concentration. managerial experience and firm age ( Smart. Dennis Lee. 1993 ).

Financia! Post-Merger Performance:

Ramaswamy examines the long-tenn financia! operating performance of the

combined finn resulting frorn rnergers and acquisitions (M&A) and sorne factors

associated with such petfo1mance (Ramaswarny, Kadandoge Padmanabhan. 1993).

The overall effect of M&A on the long term financia) operating pe1fo1mance of the

combined finn is estimated using cash flow rneasures such as the cash flow return 011

assets. computed for each cornbined firm far each of the five years. both befare and

after the year of merger.

Ramaswamy utilized regress1on analysis. t-tests and the non-parametiic

Wilcoxon .signed rank test, to examine the post-merger operating performance of the

combined finn in relation to the pre-rnerger period. l11e study found that the post­

merger operating pe1fonnance is, in general. an improvement over that of the pre­

merger pe1iod.

Ramaswamy examines the association of the relative performance of M&A with

a number of factors such as: the type of managerial compensation plans. the type of

the payment to targets' shareholders. the type of acquisition, the standardized

cumulative abn01mal returns on the two days surrounding the announcement of the

merger. the percentage of ownership by managers, the difference in the debt ratios of

the acquiiing fim1 minus the target firm, the difference in the market to book ratios uf

77

the ac4uiring film minus the target firm. the ratio of asset sales tu total asseh Juring

the ¡mst-merger pe1iod of the com bi ned fim1. and the overlap between the bus I nesses

cycle and the period of acquisition

Ramaswamy study shows pe1tomiance of M&A associated positively \\Íth the

difference in the market to book ratios of the acquiring firm minus the target film and

is associated- negatively with the ratio of asset sales to total assets during the post­

merger period of the combined firm. che difference in the debt ratios of the Jcquiring

firn1 rninus the target firm, the period of acquisition, the ·standardized cumulative

abnormal retums on the two days stmounding the announcement of the m~rger and

che percentage of ownership by managers (Ramaswamy, Kadandoge Pakmanabhan.

]<)LJ3).

Surendran. Sunil (Kent State University, Phd 1994), studied controversies about

causes and consequences of LBOs. Theory srates that, in public corporJtions.

mJ.nagers are wasteful and risk avoiders because of the separation of ownership i.líld

control. An LBO aligns ownership and control so the firm may become better

nunaged. The new managers-acting as owners also closely monitored by im·estors

\\·0uld enhance efficiency.

Critics on LBOs claim they are wealth destructive in the long nm. since the

LBOs tend to reduce R&D and capital expenditures. In the short run. however. LBOs

mJ.nagers tend to eliminare organizational waste and inefficiency because of their

inL"reased stake when they become owners.

To test this. firm accounting variables \\-ere coITelated to market behavior

thrs~ugh linear regression. logistic regression and Wilcoxon testing. The results

inJicate that the market reaction is coITelated to operating efficiency ratios supponing

the idea that LBOs generally involve targets that were inefficiently managed as public

corporations and become better managed when taken prívate (Surendran. Sunil.

\SJu-J-).

78

John D. Martín and John W. Kensinger in Exploring the Controversy over

Corporate Restructuring (1993) made an excellent review of the essence of the -

restructu1ing controversy and the methods to test it. Using an interesting stakeholder

model they give evidence regarding changes in the firm's asset ponafolio, changes in

the firm 's fina! structure, changes in organizational form, and changes in the

corporate charter and their effect on the stock retums.

Among their main conclusions they mention the growmg power of

institutional investors in disc1iminating different stocks returns of the merging and

target firms.

Manin found that acquisitions tend to substantially increase the debt burden on

the target fom, s operations, and be followed by asset sales and elimination of

duplicate functions that, on average. take shareholders to gain an immediate 3 percent

increase in value in a spinoff.

Opportunism explaining gains.

The managerial opponunism hypothesis is tested to dete1mine if factors such as

the propo11ion of outside directors on an acquiring füm's board. directors'

compensation plans. and percentage of own firm stockholding, influence

management's decision to participate in merger activity (Colie, Dennis George. 1994).

An important contribution of this research is the econometric method that

explicitly recognizes that firms voluntarily engage in merger activity. Toe importance

of recognizing this self-selectivity (which has been largely ignored by previous

researchers) is that the process may lead to a non-random sample and, consequently,

biased parameter estimates.

Therefore, the research provides a direct test far self-selection bias. Toe self­

selection bias test admits a distinction between two estimates of expected abn01mal

return on acquiring firms' common stock around a merger announcement. One

estímate is the unconditional expected abnonnal return for a randomly selected firm,

79

were its management announce a merger prnposal that is eventually completed. The

other estimate is the conditional expected abnormal return for firms which select

themselves into the sample by actually announcmg a merger proposal that is

eventually completed.

The conditional return results higher than the unconditional return. For the

author. this implies that acquiring firms tend to undeitake mergers with lower

prospects than the average for maximizing their equity values. Such finding 1s

consistent with the managerial oppo11unism hypothesis.

The principal finding of Colie 's research is that stockholders of firp1s whose

management decides to pa11icipate in merger activity and makes a successful offer can

expect a two-day cumulative (conditional) abnormal loss around merger

announcement of 1.8%. However, random selection to participate in merger activity

would be expected to produce a two-day cumulative (unconditional) abnormal loss of

2.6S-1c. Thus, stockholders of finns whose management Yoluntarily decides to

participate in merger activity are better off (lose less) than if successful merger

activity were govemed by a random selection process. Other findings were:

-the higher the proportion of outside directors on a board, the less rs the

tendency to participate in merger activity

-the greater inside directors' and outside directors' fractional firm stockholding,

the greater is the tendency to paiticipate in merger activity

-the higher inside directors' cash compensation as a fraction of the market

value of their stockholding, the greater is the tendency to participate in merger activity

Colie, s findings support previous evidence given by Kim and Schatzberg ( 1987)

who studied the stock price reaction to 73 voluntary liquidations issuing at NYSE­

and AMEX from 1963 through 1981. They found a three-day abnormal stock returns

in the acquiiing firms of 1.1 percent upon the announcement of the purchase although

statistically non different from zero.

80

Also consistent with the previous paragraphs are the findings from Bradley.

Dcsai. and Kim ( 1988) who reponed cumulative abnormal returns by the b1dding

finns for the pe1iod beginning five days before the first offer and enc.ling aftér the last

offer. or recei\·ed by the target firms with different announcement inten·als. Kim et.

al. estimated an average increase of 7.43 percent. in both the target anc.l acquiring

finns who volunarily ánnounced the merger and were prepared for it.

LeYeraged Recapitalizations

Cook and Martin (1989) refer to capital structure the explanation to negative

stock returns. They calculated significant negative wealth effect only (or those

alliances where the financia! leverage increased too much after the takeover. For firms

experiencing an increase in financia! leverage of 50 percent or more. a two-day event

date excess return was -1.73 percent and the cumulative excess return spanning the

period beginning 24 days befare the announcement and ending 25 days after was -

3.70 percent. both of which are statistically significant at 590 leve!.

A typical leveraged recapitalization involves a cash payout to shareholders that

1s generally financed through a debt issue.Takeover defense and corporate

restructu1ing technique. was addressed by Handa and Radhak1ishnan ( 1989). They

observed thar -+2 firms res01ted to the use of a leveraged recapitalization as a takeover

defense. Their results indicare taht the announcement of leveraged share repurchases

tends to observe a positive impact on share price for the mayority of the füms that

haw used it. For example. the average two-day abnormal retum for all firms was 5.52

percent. with a maximum abnormal return of over 40 percent (l"vlartin. 1993 ).

Michael Jensen (1986) offers an explanation to why le\·erage is preffered to

other merging strategies. In his "free cash flow hypothesis". he observes that extreme

use of debt brings with it a change in the processes by wich management actions are

monitored. and alters the way managers are motivated. In essence. the increased use

of debt forces cash to tlow out of the firm. Greater leverage increases the likelihooc.l

81

that the cash tlnws be reduced or eliminated and the stockholders get their nrnney nut

tlf the firm so they can once again control its investment.

When leveraged recapitalizations occurr (or leveraged share repurchases)

managers discretionary control is reduced or eliminated in terms of the firm 's cash

tlows. This provides a similar result that would have occurred if the takeover i.ll1d

subsequent restructuring actually would have taken place. thus forcing management to

take actions raiders. Jensen found that these effects are absorbed by the stock p1ices.

Kelly, Brian Daniel (1994) found consistently to Jensen that debt burden is as

important as project scale in predicting gains from mergers. The choice o_f financia!

structure and the consequent behavior of a fillll that takes more or less debt and

depends of the strncture of payments established.

Following Kelly's arguments. the net present value in project evaluations

changes as a result of the repayments outflows. bankrnptcy risks and other uncenain

demands.

One interesting implication regarding cash disbursements to loan repayments is

that firms with different capital structures that makes different revenue expectations

may rca!ize a net gain by merging their cash streams. Kelly's foundings suggest that

finns will tend to diversify across cash flows in mergers and acquisitions. An

empírica! test of this proposition analyzes the relative cash flow characteristics of

acquirers and their targets. Cash flows of acquirers are found to diverge prior to

merger. but with unclear results concerning statistical significance ( Kclly. Brian

Daniel. 1994 ).

Leveraged Buyouts and Put Bonds: the Entrenchment Hypothesis

Two authors in an article examining the effect of issuing debt with and without

··poison put'' covenants on outstanding debt and equity claims for the pe1iod 1988 to

1989 shows that "poison put" covenants affect stockholders negati\'ely J.nd

outstanding bondholders positively. while debt issued without such covenants has no

82

effect. The study found a negative relationship between stock and bond returns for

firms issuing poison put covenants. This evidence is consistent with a "mutual

i.nterest hypothesis." which establishes that the poison put debt covenant protects

managers and bondholders. but stockholders increase 1isk so getting worse off.

(Douglas. O Cook and John C. Easterwood. l 994)

A contractual innovation. known as "poison put" or '·super poison put". has

been introduced in the corporate bond market in recent years. The two principal

covenants are put options and coupon adjustments depending of the occmTence of

"risk events" like hostile takeovers. acquisitions of large stakes in leveraged buyouts.

and leveraged recapitalizations.

Reductions in bond value that sometimes occur concu1Tently with corporate

control activity are controled depending of its effect on bondholders and stockholders

position. Event risk covenants or "poison puts'' could be included in corporate debt

for three reasons. First. poison, as the name suggests. could be designed to make

finns less attractive as takeover targets and thus provide an additional mechanism for

strengthening managerial resistance to hostile bids. This vie\Y is called the by the

author as "entrenchment hypothesis".

J ayaraman (1990) tests the entrenchment hypothesis by examing the impact on

stockholder wealth of 25 poison put bond issuing dming 1986-1988. The average

abnormal stock retum for his sample is -0.99 percent at the time of the announcement.

and this estimation resulted significant statistically. J ayararnan reports that the

average abnormal stock return for protected debt was statistically lower -negative­

than the average return resulting from straight debt issuance repo11ed by Eckbo (1986)

for 1964 to 1981, but it is not different from the average return for straight debt

issuance reported by Dann and Mikkelson (1984) for 1970 to 1979.

Crabbe (1991) found that including a moderate degree of event 1isk protection

reduces the yield by 25 to 30 basis points. Fields. Kidwell. and Klein ( 1991) found

that including event risk protection reduces bond yields by abl•llt 25 basis points for

83

bonds offered after the R. J. Reynolds/Nabisco (RJR) buyout. P1ior to RJR. they

found that the inclusion of a put or other event 1isk protection did not have a -

significant effect on bond yields. Consistently, Bae, Levy, and Wannemacher (1991 ).

found that event 1isk protection has not significantly reduced bond yields. even after

RJR ( cited in Cook and Easterwood, 1994 ).

Regulators and academics have suggested that má.rket value financia! statements

provide better information far evaluating financia! institution insolvency. However.

market value accounting's usefulness in predicting distress may be limited because

financia! statement values generated by the proposed system of mar_ket value

accounting may not accurately portray future operating cash flows (OCF). This study

(Catanach, Anthony Henry. 1994) argues that cash flow from operations is easily

calculated and reflects the major risks inherent in banking, that negative OCF are

associated with higher failure costs, and that declining OCF and increasing operating

expense levels increase the probability of financia! distress. Therefore, OCF provide a

useful supplement to a system of market value accounting in the detection and

measurement of financia! distress in the financia! services industry.

Regarding heterogeneity in valuation, empirical results are mixed. A positive

relationship between dispersion of analysts' farecasts and premiums paid to targets

shareholders is faund only far füms contesting a takeover. Toe strongest influence of

heterogeneity is found in target selection. Firms with greater dispersion of analysts'

forecast are more likely to become targets than firms with lower dispersion (Fant.

1994).

Market Share Effect, Price Eff ect and Cost Effect.

An economics-based methodology is used to analyze the effects of mergers.

where data for the firms involved in the mergers is analyzed both longitudinally and

cross-sectionally compaiing merged firm data with rivals firm data (lvancevich. Susan

Herrnanson. 1994 ). The effects of the mergers are analyzed far the merged firms and

their direct rivals in terms of changes in market share, product price, and production

84

costs in the post-merger versus the pre-rnerger period. The two mergers are analyzed

both incJividually ami in aggregate. The results of data analysis are consistent \\·ith the

procJuctive efficiency hypothesis. Hence, the results are consistent with the premise

that megamergers predominantly resulted in increased efficiency within the market.

Ivancevich study analyzed the 1989 two accounting "megamergers". These two

mergers (the merger between Ernst & Whinney and Arthur Young to form Ernst &

Young. and the merger between Deloitte Haskins & Sells and Touche Ross to fonn

Deloitte & Touche) are recognized as the most significant mergers in the recent

history of the public accounting profession. The purpose of this stud)'. was to

determine the net effect of the 1989 megamergers on the market for audit services.

Specifically, three hypotheses were tested in this study: (1) that the net effect of the

mergers was predominantly the creation of market power, (2) that the net effect of the

mergers was predominantly the creation of productive efficiency gains, and (3) that

the net effect of the mergers was sorne combination of these two effects. where

neither effect was predominant (lvancevich, Susan. 1994)

Recent theoretical work has revitalized the notion that vertical integration can

harm welfare through the foreclosure of markets. Using a meaningful definition of

foreclosure based on changes in the p1ice of the intermediate good, this dissertation

explores how changes in market structures caused by vertical merger can lead to

injury to competitors, lessened competition, and reduced consumer welfare (\Valdron.

Randall E. 1994).

A model of successive oligopolies is employed, along with a game-theoretic

approach to the merger process. In this model, firms have two incentives to integrate:

a pro-efficiency incentive to reduce successive markups, and an anticompetitive

incentive to foreclose a downstream rival by raising its costs. A vaiiety of paramettic

settings and altemative game structures are used to show the different conditions

leading to welfare improving and welfare reducing outcomes.

85

Foreclosure Mergers.

Integration becomes a meaos of competition, and the choice of merger paitner is

a strategic variable. Observable characteristics of vaiious merger pattems are

discussed in a investigation, suggesting that integration resulting purely in foreclosure

wi-11 exhibit distinctly different attributes compared to multiple efficient mergers that

lead to intensified competition.

Waldron Randall studies how foreclosure, for exampk. mises the prices of the

final goods and increases the profits of the integrated and foreclosing firms, while

multiple efficient mergers lower final goods prices by eliminating markups, and

profits can rise or fall. The model is applied to the cement and concrete industries of

the l 960's, where a number of vertical mergers were successfully challenged by the

Federal Trade Commission as foreclosing markets. The application of the model

suggests that the FTC policy was inappropriate far prevcnting foreclosure: the

mergers most aggressively attacked were most likely desirable welfare improving

· mergers. By concentrating on markets where multiple efficient mergers were

occurring. The FTC appears to have intervened to stop efficiency enhancing

integration. To the extent that any mergers in these industries caused foreclosure,

these were likely to be overlooked by the FTC because rhe misguided focus of

investigation (Waldron, Randall E. 1994).

Related and Unrelated Mergers.

Little success has been reached in identifying what factors cause changes in the

volume of merger activity. One weakness with past studies is that mergers between

fim1s that supply similar products, or utilize similar production and dist1ibution

techniques, are not analyzed separately from mergers between firms that have no

commonality. Aggregation may result in misleading conclusions since the economic

86

and institutional environment may affect related mergers differently than it intluences

unrelated mergers.

Flanagan. Dennis (1992) in his dissenarion analyzes the effect of the economic and

institutional environment on aggregate. related and unrelated merger activity. The

author uses The Federal Trade Cornmission (FTC) Large Merger Se1ies. The FTC

se1ies nms from 1950 through 1979. A new aggregate mergers and acquisitions data

se1ies. running from 1972 through 1990. is developed using the Compustat data base.

The author affirmed that cycles in the aggregate and related merger series are

found to be positively correlated with cycles in gross national product (GNP), -

business investment and stock prices. Cycles in the unrelated merger series were also

found to be positively correlated with cycles in GNP (Gross National Product). The

hypothesis that aggregate corporate profits positively affect the aggregate. related and

unrelated merger series was supported. The Tax Act of 1986 negatively affected

unrelated rnerger activity. The Tax Act of 1986 was not found to affect related merger

activity significantly. Changes in amitrust regimes were not found to affect the

aggregate. related, or unrelated merger series (Flanagan, David Joseph. 1992).

Forward and Backward Integration. The Use of Moderators.

Although previous research has provided strategic managers with lists of

advantages and disadvantages associated with vertical integration, it has also resulted

in conflicting results regarding the vertical integration-firrn perfoITI1ance relationship

(Pray, Bevalee Burton. 1992). There may be a number of reasons why equivoca!

conclusions have been drawn from previous research. In this study two potential

reasons are explored: (1) the impact of moderating variables and (2) the measure of

film perfonnance.

This investigation explores two moderators in the vertical integration-firm

performance relationship: first, whether the integration is forward or backward and

second. whether the acquisition is related or unrelated. Second, it is argued that by

87

using market rather than accounting data to measure film performance a more timely

view of firm pe1t"ormance can be gained. This research tests the impact of two

moderators. forward versus backward integration, and related or unrelated

acquisitions, on returns to an acquiring firn1's shareholders by utilizing the event­

study methodology.

Results of the overall sample indicare that nó abnmmal returns are accruing to

the acquiiing film du1ing the announcement of a vertical acquisition. When the

sample is tested for moderating variables, there does seem to be sorne weak evidence

that unrelated ve11ical acquisitions outperform related vertical acquisitions. Bowever.

whether the integration was forward or backward is not supported as a moderator.

From these results the author concludes that whether the acquisition is related

or unrelated may act as a moderator in the ve1tical integration-finn pe1tonnance

relationship (Pray, Bevalee B urton. 1992).

Acquiring Füms Gains and Ownership Concentration.

The effect of ownership concentration on abnormal retums to acquiring firms

during mergers and acquisitions is examined using data compiled from merger

listings, the ownership concentration study by Demsetz and Lehn (1985), and CRSP

data.

Their overall results show that ownership concentration has a slightly negative

impact on cumulative abnormal returns accruing to acquiring finns. The negativity is

not monotonic, however. and comes mostly from fitms with above average ownership

concentration. Bidders with ownership concentration below what may be the effective

level of control are not significantly affected by ownership concentration.

Individual and family holdings have a significantly negative impact on bidder

returns whereas institutional holdings do not. Large institutional shareholders may

counter the negative impact of family shareholders. Ownership concentration was also

found to be negatively coITelated to the change in the systematic risk of the acquiring

88

firrn i"ollowing the rnerger. The results provided evidence of agency prnblerns

between insiders and outsiders in the context of rnergers. but do not provide evidence -

of similar agency problems between shareholders and managernent m bet\\'een

shareholder and bonc.lholders (Choi Unghwan. 1992).

Joint Ventures.

Ca11er, Michael Wayne ( 1994) reviewed how joint venture and licensing

agreements have emerged as popular substitutes for more traditional means of inter­

corporate contracting such as mergers, acquisitions. and asset purchases. A feature

which sets these two forms of contracting apart from the others is that finns retain an

mvnership interest in assets contributed to these activities. They differ from each other

in that. with few exceptions. licensing contracts do not change the ownership of the

targeted assets. while many joint ventures create shared ownership of the assets

devoted to the ventures.

The favorable wealth effects associated with asset acquisitions. corporate

com binations, and expansion into foreign markets have well established theoretical

foundations in Finance. While theoretical models converge on the benefits which may

be derived from using licensing and joint venture activities in domestic and foreign

markets, the conclusions drawn from the related empilical investigations of joint

ventures have not been consistent.

Studies by McConnell and Nantell (1985) and Lummer (1983) find that

significant gains in stock prices are associated with the establishment of domestic and

foreign joint ventures. respectively. Recent studies of foreign joint ventures have

cornbined to yield the ambiguous result that this activity is either wealth-increasing.

wealth-decreasing. or wealth neutral for the shareholders of panicipating fi1ms.

Additionally, sorne of the hypothesized benefits from licensing assets have not been

subjected to ernpi1ical validation. This study focuses on the response nf stock prices

to announcernents of joint \·entures ami licensings. The study includes an analysis of

89

the intluences of insider ownership ami hrm size (market value) on the reaction of

stock price.s to both type.s of announcement.s. The re.sults show that licensing

agreements re.sult in significant increase.s in the market value.s nf participating firms.

Firm .size exerts a positive intluence 011 the market's reaction to licensing

agreements. but it negatively affects stock prices when international joint ventures are

created and when one member of a domestic venture is substantially larger than the

other.

Mergers Efficiency Versus Market Power:Valuation Effects.

Market power studies have based its analysis exclusively on capital market

data which could be considered ill-suited for market power tests. Also, antitrnst policy

creates a bias against mergers. (Singal. Vijay. 1992). Toe thesis develops hypothese.s

to evaluate the role of market power in mergers and tests them by investigating the

effect of mergers on (i) the merging firms' airfares in the product rnarket and on (ii)

abnormal returns to merging firms in the stock market. Since exercise of market

power affects other airline finns in the market, the analysis is extended to study the

effect of mergers on (iii) rival firms' ai1fares and on (iv) abno1mal retums to 1ival

fim1s.

Concentration Power.

Merger market reaction could also be anticipating concentration power (Tomlin.

Jonathan Trnman. 1994). Tomlin reviews how many recent studies have attempted to

determine the competitive consequences of horizontal mergers by examining how the

announcement of these mergers affects the stock prices of competing fiims. The

common result obtained in each of these studies is that. on average. competitors

expe1ience positive abnonnal stock returns upan the announcement of a merger in

their industry. Explanations as to how the announcement of horizontal mergers affects

the stock p1ices of competitors. however. have differed drastically. This dissenation

90

emplnys a recent data set of horizontal and non-horizontal mcrgers to prnvide

eviJence on this unsettled issue.

Previously proposed hypotheses are empirically examined. The hypothesis that

horizontal mergers signa! an increased probability that competitors will rnerge as well

cannot explain the persistent finding of positive abnonnal stock returns for

competitors. Although rival returns tend to be higher in highly concentrated

indust1ies. concentration alone cannot explain the positive abnormal returns rivals

expenence. Ho1izontal mergers were found to affect rival returns through severa!

channels.

The results of this study show that the method of payment in a takeover is

shown to be an impm1ant detenninant of rival returns. It is an empirical regularity that

both of the direct participants in a takeover tend to experience lower abnormal stock

returns when the method of payment is stock as opposed to cash. This study finds that

rivals also tend to experience lower abnormal retums when a horizontal merger is

financed through stock. These new findings suggest that examining rival stock

reaction is capable of providing new evidence on the role of takeovers quite apan

from their competitive consequences (Tomlin. Jonathan Truman. 1994).

Sheikh Hussin Ayman (1994) described a process far horizontal mergers and

uses this process to draw conclusions as to the likelihood of mergers taking place in

equilibrium. The theory utilizes concepts from the theory of games and strategic

beha\'ior. A majar problem with such theory is that it assumes a significant leve! of

sophistication on the part of economic agents.

Target Opposition and Size Effect.

A dissertation studies tender offer bids and the dete1minants of bidding firn1s'

initial shareholdings of the target finns in tender offer bids toeholds (Asquith. Daniel.

1992). A zero toehold is less likely in offers that are opposed by target management.

Toelllllds decrease slightly with bid premia. but this decrease is not statistically or

91

economically significant. Positive toeholc.ls often attracts competing bic.ls. but the

finc.ling was not statistically significant.

There is a long stanc.ling c.lebate whether takeovers are socially beneficia!.

Asquith argues that if. on balance, takeovers are socially beneficia!. then value

c.lecreasing bic.lders may serve a positive role.

Takeover Regulation Effects on Multinational Mergers.

Literature on mergers and acquisitions has shown that the bic.lding fom's

shareholders in c.lomestic acquisitions obtain minimal or negative retums a~ound the

e.late of the announcement of an impending merger or tender offer. In domestic

transactions target firm shareholders tend to reap the benefits in the form of positive

retums. Restrictive U.S. takeover regulation in the form of the Williams Act of 1968

has been shown to have altered the U.S. environment for takeovers and altered the

pattern of the parties' retums (Sudia, Joseph Andrew. 1992).

The basis of this study are the the01ies regarding efficient markets' mergers

(synergy), portfolio theory (diversification), as well as considerations of capital

market integration. Ea.sed on this, this paper establishes a link between the domestic

policy enactments and the retum pattems for U.S. multinational acquirers. Domestic

c.lisclosure costs due to a changing U .S. regulatory environment. influences synergistic

value creation. differential regulatory environments around the world, and risk

rec.luction through geographic diversification. An event time regression analysis for

323 finn announcements of foreign acquisitions by U.S. listed firrns is run with

changing U.S. regulatory environrnents of Canada, the United Kingdorn, France, W.

Germany. and the European Econornic Comrnunity (EEC). Implications found by the

outhor are that the results bolster the arguments for foreign diversification,

international capital market efficiency and integration, and domestic policy spillover

effects in the takeover market (Sudia. Joseph Andrew. 1992).

92

Rol of Taxation and Merger Success

Hayn (1989) provides ev{dence that tax considerations play an impo1tant role

in explaining the abn01mal returns to shareholders of both target and acquiring finns.

The most prominent consideration in tax-free acquisitions involved the amount of net

operating Joss carry-fo1wards and tax credits due to expire. Toe study also found that

obtaining tax-free status for the proposed acquisition tended to increase the likelihood

of completion. Legislation is under consideration by the lülst U.S. Congress,

however, to restrict acquiling firms from taking advantage of tax loss carry-back

provisions. A tax code neutral regarding mergers is one of the main implications of

this study.

The welfare effects of profit taxation and horizontal mergers policies are

analyzed recently by Cheong, Kwang Sao (1994). A signalling model is utilized to

investigate the consequences of corporate taxation in the presence of an adverse

selection problem for equity-financing. Corporate taxes affect the signalling costs as

well as the profitability of projects. The tax effects are analyzed for altemative

depreciation schemes and loss-offset provisions. Due to the risk-absorption of taxes.

füms actually bear lower risk with higher tax rates.

Also, Cheong examines the efficiency and incidence of a proponional tax on

risky income in a general equilibrium model with occupational choice. As the high­

productivity agents are more scarce. a stronger signal is necessary, but a lower wage is

paid. The tax does not always discourage entrepreneurial activities, but when it does.

workers share the tax-burden with firms.

Therefore, regarding horizontal mergers and antitrust policy his analysis showed that

mergers are more likely to be profitable but less likely to enhance the consumer's

surplus or the social welfare than previously expected. These anti-merger implications

are further strengthened in the results of the dynamic model where he found that

mergers of symmetric firms always obtain short-term excess gains duting transition

93

periods. Cost-saving mergers may improvc social welfare. ami may even benefit

consumers; however. oul<;ide fi1111s lose whenever consumers gain.

Ghosh, Aloke (1994) uses a fundamental valuation process with financia) and

nperational info1111ation to assess future earnings and 1isk to aITive ata conclusion on

the p1icing of a risky investment project. He shows that the market panicipants use

this fundamental valuation process to assess the premium paid by acquirers to tai·get

fi1111s following disciplinary takeovers. Using changes in Value Line forecasts before

and after mergers announcements as a proxy for the investors' info1111ation about the

fundamental values of the target fi1111, he showed that this valuation plays a ~ignificant

role in the investors' assessment of the target shareholders premium following the

takeover announcements.

Firms experience no direct cash flow consequences from the amortization

since no tax shields to the fo111 are provided by the reduction in eamings (Hethcox.

Karhleen Blackbum 1993). This research investigates the relation between goodwill

and security prices by using standard event-time methodology to analyze common

stock returns around three dates at which infonnation on goodwill resulting from

merger becomes publicly available. Employing a sample of 116 acquisitions occunfog

during the years 1984-1990. this study finds a negative association between increased

goodwill from a purchase combination and abno1mal stock returns of acquiring firms

after controlling for method of payment, tax status. post-regulation time period. type

of acquisition. size of acquisition. depreciation, and leverage.

The relationship between creating alliances and tax stimulus is strongest at the

announced completion date of the acquisition and at the first quarterly eamings

announcement after the combination of firms is effective for accounting purposes.

The evidence supports the hypothesis that the market considers the increased goodwill

when valuing firms involved in purchase combinations and responds negatively to

that increase (Hethcox. Kathleen Blackbum. 1993).

94

However, different kinds of taxation problems arise from mergers. Due to the

merging company no longer exists, it is imponant to determine how the transferred

assets are handled far tax purposes. The 4uestion of an eventual merger difference

(merger result) has to be solved. This difference exists when the net assets transferred

through the merger are of bigger or smaller \·a]ue than the price of the shares the

receiving company has paid (Immonen. Raimo. 1992).

According to the present US mies merger profit can be taxable income under

certain circumstances. the merger loss can be deductible in the business_ taxation.

These kinds of tax consequences are problematic especially in case of so-called tax

neutrality. If the taxation is neutral the decisions of the tax payers are not influenced

by tax consequences. Both merger profits and merger losses can affect the decisions.

When. for example, deductible merger losses can be used to benefi.t the receiving

company the merger can be carried out even though the merger was not economically

reasonable.

In Raimo's research the merger taxation has been examined mainly through the

neutrality hypothesis. Taxation will not become an obstacle to the company

reorganizations through mergers but the tax effects of the merger result can direct the

decisions of the companies. This kind of influence can be described as an unneutral

feature. When compared internationally the ta.x treatment of the merger profits and

merger losses is rather exceptional. Normally merger profits are not subject to

taxation and merger losses are not tax deductible.

The tax merger regulations does not allow the tax burden always be

anticipated. because part of the assets are valued at their market value. and in merger

the property is not de facto sold. The price must therefore be estimated. Further. the

regulation is complicated because sorne assets are added when the merger result is

calculated. When the taxation procedure is concemed, the regulation establishes the

companies be taxed separately until the merger is completed (Immonen. Rainrn. 1992 l

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Tax incentives o,iented mergers are studied by Moden. Karl-Markus ( l lJlJ3) He

identifies asymmetries in the tax system, e.g .. lack of loss offset and rnles against

share repurchases. as conducive for mergers. Other features. such as preferences for

capital gains over dividends and taxation of capital gains only on realizati\)11. or so

called "lock in effects". also bias the tax system in favor of mergers O\·er new

investments.

An empirical study of the Swedish manufacturing industry is performed. The

direct tests give only weak support for a major importance of the tax motive for

mergers. However. larger companies have been able to use their tax deducl:ions more

efficiently than smaller firms. and have therefore a lower cost of capital. This is an

indication of a pro-merger bias of the Swedish tax system.

With respect to the role of tax incentives in the localization decision L1f

multinational companies. if countries do not cooperate explicitly in tax rate setting.

the result will be an inefficient allocation of the world's capital stock. Go\'emments

may engage in competition to attract foreign direct investments by lowering their

effective tax rates. If countries are of unequal size the game may be one of follower­

leader type. with the largest country being a leader.

The empi1ical results. on Swedish data. indicare that the Swedish effective

corporate tax rate has adjusted quickly to changes in the average effective tax rates

abroad. Sorne support for this hypothesis in the case of the U.S. is received. The U.S.

is also identified as a leader of the tax setting game during the sample period I Moden.

Karl-Markus. 1992).

Contagious Mergers.

In the acquisitions and mergers within the financial industry only occur with

the approval of the Federal Reserve Board. Toe Federal Reserve Board utilizes

econometric models in an attempt to predict what the changes these acquisirions and

mergers will have nn other banks (Flanegin. Frank Richard. 1993). Using im-(-i1111atiL1n

frnm the Federal Deposit Insurance Corporation and the Federal Reserve Board

Flanegin study empirically tests for the overall contagion effects caused by a

acquisition or merger within the financia} industry.

The study also tests for differences in the contagion effects based on whether

the merger is present market expanding or new market penetration. The empi1ical

results indicare that there are statistically significant negative contagion affects

accruing to shareholders of present market expanding contagious banks. while no

such affects exist for banks contagious to new market acquisitions.

Narayanan . Savithri L. (1994) found that the banking industry in_ t~e United

States has undergone significant changes in recent years as a result of deregulation

and interstate banking. Narayanan found that. after a state pennitted interstate

banking. and medium banks in that state altered the composition of their loans mainly

by increasing the proportion of commercial loans and decreasing the proportion of

loans to individuals.

Small and medium banks also decreased their holding of high-grade treasury

securities and held more low-grade government-backed and corporate secmities.

Economists have argued that geographic restrictions on banking in the United States

limit the effective diversification of bank portfolios, and liberalizing these restrictions

would result in reduced 1isk and increased profitability. In the l 980s severa! states

relaxed geographic restrictions on banking by allowing out of state banks to open

branches in their states. The study suggests that failure and merger rates increased and

profitability decreased for banks in the states that liberalized their branching

restrictions.

Cost efficiencies. economies of scale and merger relatedness are studied in U S

commercial banking by Bisceglio, Anthony F. ( 1995). He found that when planning

an intramarket merger. bank managers typically forecast savings of approximately

30% to 40% of the expenses of running the smaller bank within three years

estimulating merger banking acti\·ity. However. many regulators and academic

97

economists argue that numerous empirical studies have failed to establish the

existence of economies of scale in banking. This study provides evidence that bank

mergers are cost-saving.

Utilizing standard methodologies. an analysis of the dispersion of costs.

economies of scale and cost efficiencies are made for 495 northeast commercial

banks. The merged banks were examined pre and post merger. to determine whether

the mergers were likely to creare efficiencies ex-ante and or ex-post. Bisceglio found

no evidence for economies of scale. A wide dispersion of average costs was found for

banks of similar size. Managerial efficiency differences were very large_ r~lative to

scale efficiency differences. There can be merger-related cost if there is substantive

variation in the cost structure. The evidence also suggests that interstate banking

would not create very large banks with considerable cost advantages. Size alone does

not guaranty cost advantages. Toe banking organizations that prospered in the

interstate banking era will be those that are best at establishing and exporting

management efficiencies, not necessarily the largest (Bisceglio, Anthony 1995).

An Ohio State University dissertation assesses the impact of the Chilean

financial reforms. implememed gradually over 1974-81, on the cost strncture of the

Chilean banking system, by measuring the incidence and magnitude of economies of

selle and of scope over the 1984-91 period (Nauriyal Bharat Bhushan. 1993). Based

on duality theory. Chilean banking institutions are modelled as multi-product finns.

Utilizing monthly data on 37 financia! institutions, a tanslogarithmic multi­

product cost function is estimated and measures of economies of scale and economies

of seo pe are deri ved for each of the eight years (1984-1991 ), as well as, for se ven

different groups into which the Chilean financia! institutions can be classified.

Findings indicare persistent and significant economies of scale in the operations o.f

Chi/ecm financia! institutions, though the .findings on economies of scope are notas

unifrJnn C/11(/ consistent.

98

The small market s1ze with limited possibilities for expans1nn. and the

ag:ressive competition for market shares. banks operating in Chile have relied on their

ability to create and develop specialized market niches for their services. The low

number of mergers current Central Bank policies to repurchase the non-performing

portfolio obligations as well as the pattern of ownership of banks. and other

reg:ulatory policies conceming closure of branches or. cu1Tent labor laws. are sorne

factors which neutralizes the attractiveness for merging. A rehabilitation for the

Chilean banking system will require changes on merging regulation (Nauriyal Bharat

Bhushan. 1993).

Merger effect of Accounting Practices.

Evidence frorn the non-financia! sector indicares that acquisition accounting

methods (AAM), board composition (BC) and ownership structure (OS) have a

significant impact on bidder returns. Since the operating and financia] risks of

financia! firms differ significantly from those of nonfinancial firms. a study done by

Munhy, Vijaya Subrahmanyam (1993), extends previous research by examining the

effects of AAM, BC, and OS on bank acquisitions. He found that for banks involved

in acquisitions, the abn01mal returns to bidders associated with the pooling method

are significant and negative. while those associated with purchase are insignificant.

This result is distinctly different from the results seen in the literature, where

researchers in corporate finance find that returns associated with purchase are

significant and those associated with pooling are not. Using Parkinson's test for stock

retum volatility, the author found that there is a greater volatility of returns associated

with pooling than with purchase. He also found that the average tenure of independent

directors is also inversely related to abnonnal retums. perhaps indicating that

directors with long tenures may be coopted by management to some extent. Last. he

found a positive relation between abno1111al retums and a\·erage ownership by outside

directors. consistent with expectations (iv1urthy, Vijaya Subrahmanyam. 1993).

99

Predicting Mergers

Prediction of financia! takeovers is tested in a very interesting study done in

South Africa. The purpose of this study was to determine if acquisition candidates can

be predicted a number of years before the takeover. Financia! ratios and other

financia! variables were used in the construction of the model. A total of 114

companies were used in the study using only quoted industrial company data. period

1975-1993 (Schoeman. Willem Jacobus. 1994).

The financia! ratios and other financial variables were firstly an<:1lyzed on a

univariate basis to distinguish between target companies and non-target companies

and between targets and raiders. Initially 79 variables were used and were reduced to

7 financia! ratios and variables. On a univariate basis it was found that targets were

smaller than non-targets, targets return on investment were less than their non-target

counterpa11s, targets made more use of financia! leverage than non-targets and that the

growth rate of their assets were more or less the same.

A multidisc1iminant analysis was employed to create a model which predicted a

takeover target. The reasor: to use discriminant analysis is that it makes use of data

that is n01mally distributed. Financia! ratios are not normally distributed. so different

models were developed in this study to predict takeover targets 75% coITectly one

year before takeover. Toe use of published financia! statements and other financia!

info1mation can be useful in the prediction of a takeover target (Schoeman. Willem

Jacobus. 1994).

In another study, (Katsabekis, 1994) prospective M&A targets are identified

on the basis of a classification profile that includes a specified set of "fundamental"

factors and "market" indicators. A case-control methodology is implemented to obtain

estimation and validation samples of matched targets (cases) and non-targets

(controls). Control sampling is stratified for industry, beta-1isk and event­

annuuncement effects.

100

Two alternative approaches were followed in specifying model variables: comrnon

factors extraction and stepwise discrimination. Two specified models were tested . .

which differ only in terms of the market indicators employed. Results were obtained

with two multivariate statistical methods: discriminant and logistic analyses. The

method between 41 and 45 targets from a total sample of 96 such firn1s. In addition.

21 other targets were not identified on time with 6 targets identified on announcement

days. On average. target returns range between 22% and 39% over holding periods

between 76 and 95 trading days, with a beta-risk profile that ranges between 0.90 and

1.1 O against the sample population of New York and American Stock Exchange firms

(Katsabekis, Dimitrios John. 1994).

Morale for Predicting Merger Success.

Despite widespread merger and acquisition activity, little empirical research

exists explo1ing the processes involved and the factors contributing to ultimate

success or failure of these unions (Overmyer Day, Leslie Erin. 1993). There is a lack

of theoretical models describing organizational changes occurring during the alliance

process.

Ove1myer reviews the psychological aspects of mergers and acquisitions. He

hypothesized that parent and target firrns perceived merger and acquisitions processes

and outcomes differently, based on their position in the business relationship and the

degree of hostility present during the negotiation.

Toe models were tested using hierarchical multiple regression and support was

found for a negative hostility-morale relationship among target member evaluations.

Survey data was obtained from 76 publically traded, U.S. firms (40 parent. 36 target)

that had participated in mergers and acquisitions during 1982-1983. Surveys were

completed by senior executives (i.e., CEOs. senior managers. human resource

managers) from both parent and target firms. Support was found for a difference

anrnng parent and target member evaluations of post merger and acquisitions morale

101

anrnng target employees. with targets reporting lower morale than parents. No

interaction was found between pre merger and acquisition organizational affiliation

ami hostility in influencing the merger and acquisition pe1formance (Overmyer Day.

Leslie E1in. 1993

Feils. Dorothee Josefine (1993) based on foreign direct investment themies which

imply that the value of a multinational enterp1ise exceeds the value of a purely

domestic finn, international acquisitions are predicted to (1) create wealth and (2)

creare more wealth than domestic acquisitions. To test these hypotheses. the

shareholder wealth gains to the combined füms in intemational acquisition~ narnely

U.S. finns acquiiing Biitish firms and British füms acquiring U.S. finns. are

estimated and compared to the shareholder wealth gams in U.S. domestic

acquisitions ..

No significant differences in the gams from domestic and international

acquisitions are found after conside1ing the impact of the number of bidders, form of

payment, level of hostility, the relatedness of the businesses of the acqui1ing and

target fiims, and their relative size.

The gains to the combined firms are larger in multiple bidder acquisitions and

positively related to the relative size of the target and the acquiiing firms. Deviations

from the average exchange rate and the relatedness of the businesses were found no to

have explanato1y power in the cross-sectional regression of international acquisitions

for the combined, acquiring, and target firms. Thus. purchasing power parity

imbalances, imperfections in the real sector or imperrections in the financia! sector

were not supported as sources of gains in international acquisitions.

Additional tests involving U.S .. British. and Ge1man acquiring finns show that U.S.

ami German acqui1ing films lose insignificantly. while British acquiring fi1ms lose

significantly in internacional acquisitions. This evidence suppons a competitive

international acquisitions rnarket. U.S. target finns gain more when they are acquired

by German fim1s than by U.S. fim1s and less when they are acquired by U.K. firrns

102

than by U.S. firms. No significant difference between U.S. target and U.S. acquiring

fi1111s from domestic and international acquisitions was found (Feils. Dorothee

J.1993).

To find those factors that conuibute to success and failure du1ing the process

of a merger is looked for in a study about city-county school systems. The two merged

school systems researched were the New Bern-Craven County School System and the

Pitt County School System. The New Bern-Craven County System, with a merger

date of J uly 1, 1981. originally comp1ised the :-J'ew Bern City School System and the

Craven County School System

A case study of the merger was conducted based on content analysis of

documents and structured interviews. Documents and archiva! records examined were

the following: charter plans: merger plans: surveys by the Division of School

Planning, No1th Carolina State Depa1trnent of Public Instruction: Statistical Profiles

of Nonh Carolina: newspaper articles: and memos frorn the State Board of Education

and frorn others who played a part in their rnergers.

Six crite1ia for determining success and failure were identified from the

literature, such as. purpose, legal details. community groups. focus on goal.

referendums, and school board decisions. The experience of each rnerger was

evaluated in accordance with these six criteria. The study evaluated the six crite1ia

ami suggested a modification by the addition of three relevant criteria: role of

supe1intendent, role of county commissioners. and the element of time. (Ca1rnl.

Nancy Lea, 1992).

The Endogeneity Problem in Predicting The Outcome of Tender Offers.

Charles A. Stone and Anne Zissu argue that previous econornetric models

designed to predict the outcome of tender offers have been estirnated incorrectly.

They illustrate that the source of estimation eITor comes frorn vaiiables which are

posited to explain the outcome of tender offers and treated as exogenous when in fact

103

they are endogeneous. Using the Nelson-Olson simultaneous e4uation model they

theoretically would correct the endongencity problem but they lnoked for an

alternative solution.

Rather than solving for the endogeneity problem with a simultaneous

equation model they use instrumental variables to de1ive consistent and unbiased

estimates of the regression coefficients. Stone and Zissu give a tender offer main

model used to estimation purposes:

In Te1ms of the Outcome:

Walkling: Outcome = f (bid premium. mood. shares owned by the bidder soJicitation

fees, opposing offer)

Stultz: Outcome = f (shares owned by the target (voting power), bid premium).

Harris and Raviv: Outcome = f (capital structure. bid premium)

Dan and De Angelo: Outcome = f (panned restructu1ing)

Shleifer and Vishny: Outcome = f(shares owned by the bidder. bid premium)

Huang and Walklin: Outcome=f (bid premium. cash)

In Te1ms of the Bid Premium:

Shleifer and Vishny: Bid premium = f (shares owned by the bidder)

Stultz: Bid premium = f (shares owned by the target)

Brickley, Lease and Smith: Bid premium = f (anti-takeover amendments)

Harris and Raviv: Bid premium = f (capital structure)

Huang and Walkling: Bid premium = f (cash)

In Te1ms of Mood:

Baron: Mood = f (shares owned by the target. bid premium)

Walking and Long: Mood=f (shares owned by the target. bid premium.compensation.

shares owned by bidder)

Morck. Shleifer and Vishny: Mood = f(fitm 's characteristics. shares owned by target.

bid premium. compensation, personal characteristic of the board of directors)

104

The results in each of the their models is that the variable BP I biJ premium) is

negatively correlated with: the outcome of friendly tender offers. the ml)od of tender

offers. and the outcome of hostile tender offers.

CHAPTER V

RESULTS

105

This research focu.se.s on imponant strategic alliances that occurred in México

from 1989 to 1994 and how these event.s were interpreted by investors in the Mexican

stock exchange (Bolsa Mexicana de Valores). More .specifically, if these events were

seen as value creation processes so increasing real returns higher than expected.

An archiva) review of the bulletins of the Council of Shareholders detected 47

official announcements of strategic alliances during that period. Although t~ere were

other joint venture announcements over this period. principally with foreign partners,

they are not included in the .sample because neither an official announcement was

made to determine the date of the announcement. nora stock or asset interchange was

com m unicated.

Joint venture events were not included as they were not registered at the

Council of Shareholders bulletins at the BMV. Thus, each year at least 4% of the

number of firms issuing at the BMV and 10% in te1ms of their outstanding value. are

consistently doing sorne kind of alliance. In te1ms of wealth invested, this would

mean decisions involving assets worth more than USD 550 million approximately

each year.

From the census of 47 strategic alliances. we kept a sample of 40 firm.s after

eliminating joint ventures, füms with very incon.sistent information or no data.

reprivatizations. and Consortiums impeded by government regulation. From this. we

gota sample size of 40 announcements for 26 füms as 14 füms made more than one

announcement. These 40 firm announcements consisted of 23 consolidations. 5

acquisitions. 9 mergers , and l joint venture announcements. One joint venture was

included because, as announced by the Council of Shareholders in their bulletins. a

stock interchange took place.

106

The sample of strategic alliances was examined to determine the

predominance of consolidations and mergers over other kinds of alliances in the

1989-1994 period. This was interpreted as sorne kind of firrns' strategic movernent

that is consistent with the tradition, farnily orientation of the organizational structure

and the characteristics of the economic perfonnance in México during that period. It

was found that 95% of the finns announced an alliance with sorne other film that was

not issuing at the BMV at the time of the announcement. This was referred as

consolidation predominance period.

As consolidation was the most common practice in the 1989-94 pe_ri1s2d arnong

the Mexican firms and as the target firms were not issuing at the BMV when they

merged. we looked for the stocks' return reactions to the alliance announcements in

the acquiring firms' stocks rather than the target firms' stocks as most previous

studies have done.

Looking for afterannouncement effects of consolidations, mergers and

acquisitions on the acquiring finns has been controversia! and no conclusive results

have been achieved (Ross, 1996). Toe results on the bidders retum reactions appear to

be mixed. but sorne studies have shown that the short run afterannouncement effect is

very small compared to that of the target firms. Also imponant is that evidence frorn

México lacks in both kind of finns, acquiring and acquired.

In Consolidations, as the bidder and the target become a more integrated firm.

the separation of the gains in acquiring and acquired firms does not make much

sense. Synergy could be realized in any of the two firms. That is not the case for

mergers where, as it was said for U.S. and England, the main stock effect is found in

the acquired firms (a review of the empirical evidence was provided in Chapter 5).

As this empírica! evidence suggests that shareholders of target firms realize

large positive abnonnal returns in completed mergers, takeovers, leverage buyouts

ami other kind of alliances. However. in Consolidations, as the bidder and the target

107

become a more integrated firm, the separation of the gains 1s not really possible

because synergy could be realized in either finn.

The explanation given in the merger empírica! behavior where targets absorb

more of the synergy effect, rests on two facts: accounting practices and on the

assumption that assets markets work.

The accounting explanation says that the sum of the cash paid to the

shareholders of the target film equals the value of the acquired assets, thus value out

equals value in, implying that the value of the merging firm can not increase with the

merger.

The perfect market assumption says that no arbitrage exists when the

acquisition takes place. Competition makes target prices reflect their true value. This

assumption reinforces the accounting explanation.

Both hypotheses may hold well in countries where strong markets and

infornrntion behave pe1fectly in a strong form. Toe absence of arbitrage would then

be one of their characteristics. This would also imply information symmetry between

the managers of the acquiring firm, the investor community, and the shareholders of

the acquiring film.

On the other hand, if information symmetry does not exist, this would create

sorne possible sources of imperfections that would invalidare that the asset markets

work perfectly, so making it possible to create synergy in the alliance process. These

possible sources of imperfections are;

First. There are agency considerations between the managers and shareholders

of the target firm. The hypothesis that managers do not always behave in the

shareholders' interests (Jensen, 1983; Asquith, 1983; Fama, 1984; and others) has

increased adepts. Asymmetry tend to vary depending the composition of the board of

directors. the stock market regulation, the role of blockholders, the generalized

accounting practices, the power of the accountant associations, and the monitoring

that the market does to the managers work.

108

Monitoring of managers work is realizecl frequently through the labor market.

the banking creclitors influence in the boarcl of clirectors. ancl the structure ancl

behavior of the stock market.

Labor market acts in controlling managers behavior when managers turnover

takes place, compensation levels (salary, bonuses. stocks. options. premiums. etc) ancl

managers labor infonnation works well. If they clo not. labor market can not

accomplish this role.

Regarding banking creditors influence on the boards of directors, this works

through the setting of debt covenants and/or the debt rating monitoring. ln _M_éxico up

to 1994. credit rating was uncommon except for international debt issuing.

Finally, the stock market also accomplishes a monitoring role through price

reactions in the BMV and in the international markets where sorne Mexican

companies are issuing bonds or ADR's. The stock market can work in a weak. semi

strnng or strong way depending on the specific circumstances in which a market

works. Regulation, number and characteristics of panicipant kind of infonnation

(quality and velocity), and political environment regarding the stock market are some

of t11e most important factors.

These factors. when working properly impede the creation of advantages for

managers of the merger firms realizables in the stock market. As obviously noted,

these gains could pass to shareholders or to the well informed managers. In

developing countries the precedent assumptions can or can not hold, and thus. sorne

arbitrage opportunities can exist in merging process. This inteITogation justified the

adopted methodology based on merging gains event study.

Three circumstances caused us to select our methodology: One, most of the

finns with official alliance announcements in Mexico dmi.ng 1989 to 1994 were

consolidations where it is not possible to separate the bidder and the target effect;

Two. most of the acquired foms do not issue shares in the stock market because they

are smaller orare related to a holcling firm that is already issuing at the BMV: and

109

three. sorne market imperfeccions are presumed to exisc in the Mexican merger

experience that can be creacing arbitrage opponunicies and infom1ation asymmetries

that allow merging foms to cake advantage of a lack of competitiveness in the asset

rnarket as well as asymmetric infonnation.

It should be noted, however, that sorne other gains are probably created in che

process, accrning to the target fi.rms which are assumed to have been much higher

than the ones measured in this work, pertaining to the acquiring firms.

In order to calculare the impact of strategic alliances on stock retums as a

proxy of the value creation that is assumed to take place, abnormal perfooniJ.nce of the

stocks of the acquiring firms was calculated. This was done by benchmarking the fom

returns to the average market return or IPC using the securicy market line or Sharpe's

model. Thus. fiims with higher retums relative to what would be expected in a 300

trading days tendency would be characterized as firms ha\·ing positive abnormal

returns. These abnormal returns were averaged across firms and accumulated for

testing purposes.

Common descriptive sta~istics were analyzed finding in mosc of the firms

better results than expected in terms of nom1ality, volatility and skewness. These

results can be observed in the following table. From this table we can see that only 18

were outperforming the IPC and 22 were not. Also imponant to observe is the fact

that firms outperforming the market befare the alliance took place, were not the same

as the firms that outperformed the market during the alliance announcement. As a

whole, the merging firms showed a higher return and higher \ºOlatility compared to the

IPC. compared to the acquired firms where measurement was possible. For the

fo1mer. the sample average retum was .14% while the IPC .11 %.

Similarly, the sample standard deviation was .35o/c compared to .08% in the

market (IPC). In terms of kurtosis and skewness. most firms approached to a No1mal

dist1ibution. with sorne troubles in the stocks of GCREMIA and GCREMIB.

MODERNA. V AMSA. and ACCELSA l.

110

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0.000491 0.02411 o 001.•025 o 00061 4.663 o 1611-t .1<,1111 09 O I O t, 0.001002 0.0158 O 0008325 O 00025 ~ '4207 1) 0351~ 1::-~1 06 O O 6 S 0.003212 0.02659 O 0014012 O 00071 .:.050J O 341.1~ O 20'J2 O I I O <

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.~. i' l N 0.000883 O 02216 0.001168 00049 1 7 O 1 l 2 . 4 S 6 S ¡;. 2 3 ..1 - •) O I O I S 9 ;.: K ::." T ¡.: r 0.001002 0.01511 0.00011325 00025 O O 6 U O 6 5

0.000936 O 011171 o 0009861 O •10035 :' . 9 1 7 O _ 4 4 1 ~ O 1 8 , ,•} 1 O . O 9 ,: ¡ r .~: r 0.001002 O.OlSI O 0008.~25 O 'J002S O O 6 O O 6 S

..... _,. s o 0.0043511 0.01723 O 000908 9 ººº~ o o s o l o J ,;;_K~T RT 0.003302 O OL361 O 000'172 O 00019 o o s O O 6 9

T :i b 1, D , s e r i p ti v , S la l i s ti e s b '! F i r m ' s R , t ll r n a n d '.\I • r k , t R , l u r n ro r t h , · 3 O O . 6 O I n 1 , r v a I

M , • n S l d . D , , .• S • E • ~l \' a r i a n e , K u r t o s i s S k , w n t s s R a n ~ , :'\I i n . M i 1 •

GCREMIA 0_001126 0.02088 O 001100.\ O 00044 .'42.06 18.259'/ 0.422? O OJ O J91

AJ,;.KETRT 0.001477 O 01591 0.0008J8J O ú0025 ::.J417 O 01044 O 127& U 06 O 065

GCREMIIJ O 00116 0.02011 O 00106 Q 000..¡ .•25 97 17 6201 404:! U OJ O J72

ARKETRT 0.001477 O 01591 O.OOOSJSJ O 00025 :! .. 1417 O 01044 .12711, .Q 06 O 065

GF.UPEC 0.003422 O 02461 O 00129i O 00061 18.054 O.J2JJ1 0 . .1458 O 18 0.161

.-IRKET RT 0.001138 .01512 O 000i967 0002J 1.3873 O 34601 0.107J •) 06 048

G F B ,t 0.000169 .02192 0011553 00048 3827 0.2779f. O ¡9,,_1 O 1 .092

A.RKETRT 0.00151 0.01584 .0008-147 O 00025 4155 O OOJiS O 12iS O 06 065

G F B B 0.000162 0.0220J 001161.~ 0.00049 1439 0.5116i .2011 ,O l 0.104

ARKF.T RT 0.00151 0.01SR4 .0008J47 00025 .4155 O 00-175 127~ -O 06 065

~FIN\'/:." R ,:. O.OOlJJ 01186 O 000625 00014 :!1_2J ·1 1306:: 15i.• .,) 09 06.1

A RKEí RT 0.00156 .01591 O OOOSJ85 O 00025 ::.JJ75 O.OOJ4- .12i~ O 06 O 065

~F/NVER 8 0.001341 0.01272 O 0006703 O 00016 ::4 524 ·l 27516 0.11;:: O 11 O 069

r\ ¡.: K t: T R T 0.00156 0.01591 0.0008J85 000.:!5 ::.J375 O OOJ4':' .12':~ O 06 065 I F f ,V \' E R C 0.001J15 0.00802 O 0004229 -tE-•)5 :!5.901 0.981~!< 1~4.> O 06 .062

ARKET RT 0.00156 O 01591 .0008J85 00025 :! .1J75 OOJ4i 0.1278 O 06 .065

GGEMEX 0.002358 0.02045 .0010779 00042 4.001 1621S 0.1844 0.1 O 066

AJ,;.K.ET RT -0.00146 O 04968 O 0016184 IJ 0024'? .102.71 -16 6724 O 91¡; O') O 054

GSERFIN A 0.00029] 0.0260~ O 001J72 00068 12.615 -1.53295 O 2608 O IS O 109

AKKET RT 0.00018 .01485 O 0007825 00022 1.1294 -0.16801 0.107J O 06 O 048

G SERFI.V B 0.000719 028S9 0.0015068 O 00082 -1 JJ18 0.2904-; 279.t ,O 13 151

A kl:ET RT 0.00018 .01485 0.0007825 O 00022 1.1294 -0.16801 10?; O 06 04R

ODERSA 1 0.00163 .04568 0.002.tl8 •) 0021 :72.13 -15-2845 0.912:i O 81 O 104

A RKET RT 0.001257 O 01J88 O 000i'J16 O 00019 ú 7162 0.224i5 0.0891 -O 0-1 O 048

0DERNA. 2 ,O 000808 .05042 0026574 O 00254 183.92 ·ll.406f. O 9828 .81 0.175

AH.KET RT .000296 .01919 .OOIOlli 0.00037 J 3094 0.214:::S O 1692 07 O 103

PO.VDERJ .35E·05 0.00935 00004926 BiE-05 70.93 4.73608 .IS56 006 0.1

t\1'.KET RT 0.003421 0.01352 O 0007124 00018 :!_4913 ·0.0405:I .1204 O OS O 069

PO,VDER 2 -0.000762 O 01248 O 00065:J8 00016 41 705 -0.84059 0.1985 ·O I O I

ARKET RT 0.002924 0144.J O 0007606 O 00021 ::.6135 -O.J2401 .1282 O 06 069

EGCOA.M A 0.004851 03069 0.0016177 O 0009-1 10.474 .786~9 .2278 -O 06 169

ARKETRT 000757 0.01801 00009492 00032 19165 -01641.:i IJll 0.07 0.065

S/TUR 001215 O 02554 0.0013459 00065 :i.1539 0.5538: 206': ,O I O 11

AJ.:.K.ET RT 0.0007)4 0.0151 O 000796 ú002J 1 0596 .0.1940:! 0.1073 06 o 048

srSKRO 8 0.001955 O 01861 O 0009811 000;15 17 ;188 1.552::.~ O '.:41S:! O':l u 158

.iJ,;.1-..'ETRT 0.002064 001J89 0007.111 00001~ 1.4145 ,0.0S.11:! 01097 1)06 0047

S)",\'KRO C O 000457 O 02514 001.•252 O 0006.l 18 224 ,1 887:t O 290:i -O 15 145

ARKE1'RT 0002064 O.OIJ89 00007J 000019 14145 ·005.11:! 0109~ ,106 047

1· A ,\( S A A 2 8 E · O 5 O O 1 4 l I O (1 O 7 ·1 O O O Q :! 6 O i 2 7 - l S 6 "! ~ S O 2 7 l _l 1 ..¡ l 2 8

A. f. K ET R. T O .O O O J J S O O 1 .\ 1\ 5 o O o 7 B O o O o 2:: l I JO 9 . O l 8 5 6 S o 1 o-; _1 ü 6 O 4 8 1· .. , .1, s A II o o o o 1 ~ 1 o o 1 2 4 1 o o -o-0~6~,------;-,-,-o-o-,-,---+-,-,-_-,-4-,---+--,-,-.-0-,-+---:-•-•-·--+-- ,J 1 -1 o 1 ..2 s .-1 r: 1-..· ET s r __ o ___ o_o_o ___ ,-,-,-+-o-o-,-_,-,-~- o o o o - " •i •) o o :!-,,---t-,c-,c-c-,--co-,,,-+--,-o~,~,~,~.~,+~-,-,~----I-·-,-.:-, ~,.-,--,-, -o-,-,.,

111

The market model regress10n results. for the 1989-1994 sample pe1iod are

illustrated in the following graphs. They showed good fit to the market during the

300. -60 day pe1iod in the following stocks: Cemex. Banacci, GFB, Alfa. Femsa.

Cifra. GGemex, GCarso, Situr, and Apasco. Sorne others adjusted lower to the market

returns; among the most interesting that did not adjust to the market during the -300 -

60 days period are Serfin, Segcoam, Moderna, Situr. Synkro, and Yamsa. A higher

volatility is a common factor in these stocks.

AdJusted Regresslon Curve lar Alfa rc:-""7cc=="'~""'"'"'=,,,,_,,,,_,,_""~"""'=

R Square Sid.Error F. Si g ni fi e anee T-R m Si g ni íi e anee D u r b i 11 - \V a l s

A 1 ra

0.052311 0.02171 4.LFA.RI

261.07195 LFA.RM o

1 6 .1 5 8 o

1.90969 0.00215 1 :;: 1 n 1

MeanSld.Dev. 0.004 -:i.031 Correlalion 0.001 .015 Signi[icance

O . 7 2 3 o

Adjusted Regression Cu~ve far Apasco """,,,,_,""""""""""""= ~"""""""""',-,--~~.,,,.,...,.,,,.,...,.,,,,"""'"'.,,,.,.~~~,.,......

Rm

(,{ ,l,j 11 11 K r t'

S Id . E r ro r F. Slt!nlílcuncc T -H. rn Sh:nlílcuncc [) u r h In· W 11.. ls A Ira n l' 1 a

k Square S1d. Error F. Sig,niíicance T-R m

Signiricance Durhin-\Vats A lía ll e I a

RI

R Square S1d. Error F. S ign iíica nce T -R m

S i~n ifica nce DurlJin-\Vats A lía Be I a

.

··.·

O. 1 9 j 2 O . O 1 6 O 5

5 (i 9 9 3 S ·I

o 7 . 5 4 9

1.63849 .00026885

0.554155

0.52346 0.01987

261.42846 o

16.169 o

2 .o 1581 0.00073787

1.253922

0.62322 o.o 1686

393.66511

19.841 o

1. 9 2 1 6 0.00099094

1.306199

M APAS(:.R 0.001 A l' A S C . H ~I . O O I

B ANA .R I llANA.RM

llANB.RI BAND.RM

M ea n O .o O 2 O .o O 1

Me• n O .o O 2 O .o O 1

:-·-:-:·:· :-:·._. -·-:·:-:,:. :,·,: .. -::·-:-

S l d .U e Y.

0.018 Corr~latlon 0.014 SltnlrlC"unce

Std.Dev. 0.029 Correlalion O.O 17 Significan ce

Std.Dev. 0.027 Correlation 0.017 Signiíicance

..

.•1-1

o

O. 7 2 4 o

O. O 3 3 O .O 3 4

l 12

I< Squ:ire Sld. Error F. Significance

T-1< m

Significance D u r b i 11 • \V a l s A lía íl e I a

·O

RSquare Sld. Error F. Signirlcance T-Rm Signiflcance D urhln-\\" als A lía Il r ta

·O

----------------------------- ------------

0.01597 GCARS.RI 61.99171 GCARS.Rl\1

o 7 .8 7 3

o 1.83409

0.003047 r, 5 7 1491

M ••n Sld.D ev. 0.005 0.018 C orrelalion 0.004 0.014 Signiíicance

AdJusted Regresslon Curve for GFB A

0.51053 0.01461 GFBA.RI

248.2395 GFBA.R:\f o

1 5. 7 56 o

1.73343 -0.00 1382

1 1 O I O 1 6

Mean Sld.D ev. 0.001 0.021 C orrelatlon 0.003 0.014 Slgnlflcance

Adjusted Regression Curve torGFB B

O .4 5 5 o

o. 715 o

113

•· ·> .... ··········

R S q u :1 re s !el. Error F. Sicnificance T -1( 111

Significance 1) urhiu-W ats

A Ira 11,·la·

R Square S Id . E r ro r F. s i J.! n ir¡ e:. n et T · R m Sil,!niricanc:e­Durbin-W als A I ía O t ta

R Square Stcl. Error F. Signiíicance T-Rm Significan ce D 11rbi11-Wats Alfa Bel a

·• ·• ... () . 4 <) O 21 o .n 1474

228 .8 8 0 8 7

o 1 5 .1 2 9

o 1. 84 2 1

-0.001247 1.066:'i,7

O . 2 O 8. 8 1 O .O 1 5 S 4

62 Bl262

7 . 9 2 5 o

l . 7 4 6 4 1 O O O 2 1

O 6 7 1 5 ~ 1

r; Fii R

G Fii 11.R I G Fii 11.R i\l

GGEME.Rl GGEME.RM

:\1 ta ll

o .ll ll l o.no 3

M 0 . 0 0 _1

O O O 1

·. ·•·•

s l el. ll ,. \' . o .IJ 2 1 C O rr l' la tio II O .O 1 4 Significan ce

s l d . D t V •

O 017 Corrtlalion O 012 Sii.?ni(icantr

AdJusted Regresslon Curve tor Sltur

0.19782 0.02293 SITUR.RI

58.69165 SITUR.Ri\l o

7 .6 61 o

1.7 5487 0.0000036935

0.687461

Mean Std.D ev. 0.001 0.026 Correlatinn 0.001 0.017 Significancc

11. 7 1 5

o

O -e 5 7

0.445 (J

114

On average. the acquiring fiims in the sample showed a positive abnormal return of

3.4c¡c at -6+6 days and of 4.5% dming the announcement pe,iod. detennined at -4. +8

115

days around the day of the official announcement, at the 1 % significance leve!. This

feature is consistent with the empirical evidence found in other studies of acquiring

forns in other countries. A detailed description of these results is given m the

following table and graph where a "U" shape abnormal returns behavior contrasts that

of other countries such as US and England. We reject the null hypotheses of no

abnormal returns

lnterval

-60 -40

-39 -20

-19 -10

-10 +10

-9 -3

-6 +6

+3 +10

+11 +20

+21 +40

+41 +60

-2

-1

o

2

Std. Dev

CAR T-Value Abs Tvalue Significance 1-Signif

0.04365746 19.8816958

-0.00563416 -2.56580804

-0.01026816 -4.67613922

0.01575057 7.17284203

-0.03114511

0.03356449

0.00250295

-14.1835433

15.2853357

l.13984633

19.8816958

2.56580804

4.67613922

7.17284203

14.1835433

15.2853357

1.13984633

0.00476512 2.1700444 2.1700444

0.0071499 3.25608008 3.25608008

0.00545258 2.48311786 2.48311786

0.0038854 l.76942013 1.76942013

0.02274678 10.3589288 10.3589288

-0.00451821 -2.05760056 2.05760056

-0.01947547 -8.86916786 8.86916786

0.01248338 5.68495481 5.68495481

0.01388785

0.000000000

0.01414598 l

0.000033028

0.000000011

0.000000000

0.000000000

0.261129996

1.000000000 100.0000%

0.9858540 l 9 98.5854o/c

0.999966972- - 99.9967o/c

0.999999989 100.0000%

l .000000000

l .000000000

0.738870004

0.035999738 0.964000262

100.0000o/c

100.0000o/c

73.8870o/c

96.4000o/c

99.7696o/c 0.002304082 0.997695918

0.017315743

0.084447545

0.000000000

0.046187212

0.000000000

0.000001310

0.982684257 98.2684%

0.915552455 91.5552%

1.000000000 l 00. OOOOo/c

0.953812788 95.3813%

l .000000000

0.999998690

100.0000%

99.9999%

116

Eight things stand out from these results: first. the pattern of the average

cumulative abnonnal return curve near the announcement date: second. the generally

favorable reaction of the market to these kind of announcements: third, the velocity at

which the market reacts to the alliance announcement: fourth, the time taken by the

market to absorb ali the new information regarding the strategic alliance

announcement: five. the total size of the positive reaction to the announcement. across

fiims: six. the reasons why firms get different CAR: seven, if the alliance event could

be forecasted, and eight, what managerial implications can take from these results.

First, the behavior of the average cumulative abnormal return curve f1ear the

announcement date: the "U" form curve is different from other empirical evidences of

similar studies in other countries. For instance, in the USA (Asquith. Paul. 1983):

Cumulative abnormal return for US bidders and targets firms.

Cum ulali~·r Ex<"ru kr1urn

+ 15

+IO

+S

Da)· t

Cum ulaliY.: [IC'C'JJ

RciurnJ

•IS TBiddu

Day O

Even summing up the two effects (as in Kim & Asquith 1987) we would not get

a "U" shape curve in the abnormal returns around the announcement date in the USA

experience. Toe lack of previous evidence in Mexico and in other emergent markets

regarding strategic alliances prevents us from compare this result to other types of

announcements.

There is just one antecedent of a "U" shape curve form in the Mexican market

to an event reaction done by Santillan, Roberto (1994). He studied the privatization

announcement effect on stock gains. Around day "O" he also detected a "U" shape

curve in México. Severa! explanations could be concerning around this "U" curve:

117

A month before the alliance announcement. the bidders· stock prices began a

diminishing retums tendency. Thus, the cumulative abnorn1al returns began

decreasing from day -32 and up to day -3. At day -2 abnormal returns began a strong

rising tendency up to day +8 validating our expectations. From day +9 and up to day

+ 3 1 there is not a clear tendency in the bidders stocks returns.

What causes stock returns to reduce beginning a month befare the official

announcement?

Short run variations in stock returns a month before the official announcement

could be caused by negative information signalling, higher trading volume,- or price

adjustments to previous overpricing regarding accounting information of the last

quarter befare the announcement (in México firms are required to disclose

information to the market on a qua1terly basis).

Negative information signalling could come from the credit inf01mation

regarding that füms are requiring more money than they used to: or probably, that the

finns are preparing themselves for sorne important changes, such as cost reductions

with employee downsizing. These cost reductions could be however interpreted by

the market and creditors as lack of cash flow or as having problems to pay

outstanding debt. Other information that the market could be taking into consideration

and depressing stock price befare the alliance is the one that emerges as an

overreaction to something that the market realizes. A strange movement is

accompanied by managers silence. "Ove1Teaction" is a new feature in explaining

stock piice large variations for protection purposes which fit very well in the traders

strategies to manage uncertainty. Managers overreact to increasing uncenainty

Reviewing press news and day by day financia! and trading reports prepared by

banks and casas de bolsa (brokerage warehouses) to the public. we did not fi.nd any

significant info1mation, regarding firms preparing to the alliance that could be acting

against the stock prices a month earlier.

118

It is important to realize the lack of consistent and significant press

announcement information of t111e alliance events. In many cases there was

infoimation regarding alliance, but they misinformed the public regarding the causes

partners and obviously the expected dates of the alliance. Also, most of the press

announcements talk about events that never occur.

Seventeen out of 22 true events were pre announced by press news a month and

a half before the alliance. Fifteen out of 22 during the second month before the

alliance, and eleven out of 22 during the third month of the alliance and six out of 22

six months before the official announcement.

Credibility about these press announcements seems to be Iow. thus. they have to

be accompanied by sorne other factors to cause stock prices to overreact. We can

affirm that, there are sorne reasons to believe that the market is recei\·ing sorne

anticipated information that may affect the stock behavior in the preannouncement

period. We can not affüm if this inside information influences traders to overreact

with a month of anticipation toward a risk minimization behavior more than a profit

maximization. Selling the stock may seem to be a good strategy if risk is perceived

and the market lacks information and competition. Traders and analysts may advice

clients to sell these stocks that look temporarily uncertain and thus 1iskier as p1ior to

the alliance. As most Mexican merging firms increased their debt ratio. reduce cash

flow (employee liquidation), reduce operations, and thus transmitted confuse

information to the analysts. they probably sell the stocks.

Inside information may affect the validity of the results of this research in that

we may be rejecting the null hypothesis more times than we should, thus rejecting that

abnormal returns are not different from zero and thus accepting that the strategic

alliance announcements may cause stock p1ices to increase significantly. \V e would

be facing a type II error and thus decreasing the power of the test.

With respect to the influence of prior information on stock p1ices during

restructu1ing processes. J Martin (1983) comments that "with 5% of higher abno1mal

119

performance in month ·o·. rejection rates for a sample size of 50 were 100% for ali nf

the methodolog1es. However. that result does not imply that an event study using

monthly data \\·iJJ always pick up 5% or more abnonnal performance using a sample

size of 50: if rhe researcher is unahle ro identify the specijú; time at which rhe

abnonnal pe,formance would have occurred, the power cd the tests for a/momwl

pe,formance fa/ Is off dramatically"

A test for \'Olume was performed obtaining a significant higher volume 30 days

before the announcement. This higher volume of allying stocks is very important in

understanding why stock returns fall right before the official date.

Toe market reaction to strategic alliance announcements, the velocity at which

the market reacts. and the time taken by the market to absorb ali the new information.

are sorne questions reviewed in this research and are related with the efficiency of the

:\1exican stock market. Toe answers provided here are very important as infer if there

were sorne pri\'ate maniqueism from the most infonned or the most experienced

traders. invalidating the hypothesis of efficient markets.

As a satisfactory result in this thesis was the finding that the Mexican stock

market did responded efficiently to the 1989-1994 strategic alliance announcements .

. ..\s these announcements changed the value of those firms engaging in an alliance. it

\\·as hypothesized that stock prices should react to this new information. Also. the

\·elocity to which the market adjusted to this situation was important as gains should

spread to many investors if no arbitrage is intended to exist (info1mation should flow

rapidly the more efficient the market is. so reducing the possibilities for persistent

higher individuals gains).

Looking at the average CAR on page 89 one realizes that abnotmal returns

Jccelerated since the fourth day befare the official alliance announcement. This

:mticipated price movement rnay be interpreted in that sorne prívate infonnation was

tiltered out creating rnanagerial opponunities. As it was anticipated in the

methndnlogical chapter. four days are many days for trading with ad\·antage if the

120

open volume dnes not increase from its tendency. so well informed traders can get

attractive returns. If this does not happen we can not affinn that privare gains can be

formed through anticipating the market (beat the market).

Underp1icing of assets would mean that the asymmetric infomrntion

works as managers can beat t.he market before other investors realize that the assets

were wmthing more than they thought. Therefore, sorne authors relate umlerpricing to

an inefficient stock market which is not longer able to invalid the superior knowledge

of the company for some managers so they are able to buy the company in the public

capital market for a price that is below its value based upon their inside infor!:11ation.

The asymmetric inf01mation develops in long periods of significant increases in

CAR. Although not all the firrns'announcements were CAR increasing in the

Mexican expe1ience, the 4.5% CAR average in a -4,+ 8 days period had a rank of

minus l 2.969c to + 33.64%. Toe rank help us to interpret differently the average

abnormal performance of 4.5% which subtracting the bidding commission, would

lea ve in Mexico 2.8% of net gains in approximately ten days.

The 4.5% average wealth effect in the -4,+8 days announcement period means

more than 15 000 million pesos apprnxim:i.tely in ten days (in constant 1994 terms).

The reader should remernber that this wealth effect must be summed up to che

positive effect in the acquired firms that is hypothesized be larger than the one found

in the acquiring firms.

Combining the reasoning that sorne p1ivate information was filtered out four

days before the alliance to the decreasing performance noted -30 days before the

alliance and explained at point JO. one can conclude that an average of 10.5%

abnormal retum (cumulative) could be created if managers maniqueism did existed.

However, even if chis maniqueism would exist it seems difficult to believe this could

be captured by well inforrned investors given the rapid response of the market to

events.

121

The gains were spread rapidly in the markd as the highest increase in CAR

occurred on day zero (a very strong efficient market); the other high increases were on

days one. minus one and two in that nrder. This Jeaves small room for privare

approp1iation of abnmmal profits. Therefore. we can say, at least regarding these kind

of annnuncements. that the Mexican market worked efficiently in a strong way. as it

realized rapidly the new info1mation regarding the changing value of the firms and

sharing it with the rest of the market. This author appreciation of how the market

distributed the extraordinary returns among investors corroborated the assumption

that the Mexican market worked efficiently (for this wider concept of .efficient

markets see Fama, Eugene 1988 and Jensen, Michael 1988).

What remains unknown is who (investors) selected correctly the best stocks

and who did not, and if there was some persistency in doing this from e\·ent to event.

Information regarding the customers that buys stocks at what time of the sessions is

not available. so we were notable to know if the institucional investors did better or

not compared with the non institutional investors confronting maniqueism hypothesis.

Thus, it remains the doubt if the panicipants who did well in anticipating the

alliances are the same as those who bought stagnant or even CAR decreasing stocks.

If the fonunate participants are the same as the unfortunate ones. a 4.5S} CAR would

be the result, but if they are not the same, the winners can get a very much higher

abnormal return. As it was said, this remains unknown.

The fifth behavior that was raised in the methodology to look for. (i.e. the total

size and distribution of the CAR reaction to the merger announcement across firms).

this research found that sorne fiims outperformed others in terms of abnonnal returns

during the announcement period. Their performance wa.s found to vary depending the

characte1istics of the firms, the moment and circumstances the announcements were

made. the economic environment .situation. and the kind of alliance involved.

The highe.st increa.se in the cumulative abnormal return (CAR) wa.s 399c in

Synkro A. 29% in Synkro B. and J 9C-} in GAFIN while the lowest increase was fnund

122

in Segcoam. Ponder 2, and Accelsa with -. 13%, -. 12%, and -.10% respectively. It is

interesting to imagine the effects that an investor could have had if in their po1tfolios

included any of these securities. Being up or· down, their effect is very high for only

ten days of trading; this makes alliances interesting enough.

What made some stocks to increase their abnoimal retums as much as 39%

while others to reduce as muchas - .13%? Sorne answers will be provided in the next

paragraphs.

Cumulative Abnormal Return for Allying Firms -4,+8 days period Mexican Firms, 1989-1994

Issucr -4 +8 lssuer -4+8 Issuer -4 +8 SEGCOAM -0.12960034 ALFA 0.00618565 GCARSO 0.09156334 PONDER 2 -0.11677239 ECKO 1 0.01824328 ABACOA 0.0944693 ACCELSA I -0.10289611 GSERFIN B 0.02899795 ABACO B 0.09639614 FEMSA -0.07065668 GCREMI A 0.03561427 VAMSAA 0.10010984 ~lODERNA 1 -0.06990318 GCREMI B 0.03561427 GFB B 0.11086009 GGEMEX -0.04707237 CEMEXA 0.04358035 GFBA 0.12744001 CIFRA B -0.03547902 CIFRA C 0.05775189 GAFINB 0.15072081 APASCO -0.03097248 BANACCIB 0.05778922 SITUR 0.16386961 GFINVER C -O.O 1828076 CIFRA A 0.05859923 GAFIN A 0.18849273 ECK02 -0.00892155 ACCELSA 2 0.06330147 SYNKROC 0.29212569 GFINVER B -0.00307806 CEMEXB 0.06373511 SYNKROB 0.33641855

GSERFIN A -0.00266625 MODERNA2 0.07237319 PONDER 1 -0.00203125 BANACCIA 0.07314866 Mean 0.04533976 GFINVERA -0.00020883 GEUPEC 0.08106605 Std. Deviatio 0.09651711 V AMSA B 0.00366313

Arrnnging data for the economic sector each firm belongs, we observe that the

highest cumulative abnormal retum is obtained by the sector Financia! Services with

5.9% CAR during -4, +8 days period. Afterwards, the sectors called Various. and

Transformation got 4.9% and 4.4% respectively, being all these the best performers.

Cumulative Abnormal Return for Economic Sector in -4,+8 days period

Mexican allying firms 1989-1994

EcoSector CAR -4, +8 Max/Min car n Sector l Mean 0.0585974 Max 0.1884927 19 Fin. Servs. Std. Dev. 0.0766876 Min 0.1296003

Sector 2 Mean 0.02544 76 Max. 0.0637351 4

123

ConsLruc- Std . Di.:v . 0.0498896 Min O.OJ09724 I i o II Si.:cl m .~ Mi.:an 0.0440790 Max 0.3364185 11

Transfor- Std . Di.:v . 0.1466624 Min 0.1167723 mation

Si.:ctor 4 Mean 0.0269573 Max 0.0585992 3 Commi.:rci.: Std. Di.:v . 0.0540731 Min 0.0354790

Si.:ctor 5 Mean 0.0488744 Max 0.0915633 3 Various Std. Dcv. 0.0603711 Min 0.0061856

Total Mean 0.0453397 40

Also interesting is to observe that with the alliance, within each sector there

are sorne finns that showed positive CAR and sorne others did not. This creates

important considerations for pmtfolio selection as economic sector by itself does not

seern to be a clear variable for portfolio selection. This lack of univaiiate

determination is an imponant characteristic for predicting alliance events as well as

CAR size -success or failure-. Therefore, a multidi.scriminant model was nm out for

better predicting results.

Analyzing the CAR results for size of the finn, we note that the smallest firms

got better cumulative abnormal return with 5.8%. Following to these. the biggest

fi1111s ob.served 5.2% and the big füms 3.6%.

Cumulative Abnormal Return for Size of the Firms in -4+8 days period

Mexican allying firms 1989-1994

IFirm size CAR MEAN FOR -4 + 8 ANDMAX MIN. VALUES &

Size I Mean 0.05800928 Max 0.33641 855 (Least Big) Std. Dev. 0.15493075 Min -0.116772 394

Sizi.: 2 Mean 0.03583164 Max 0.188492733 (Big Firms) Std . Dev. 0.08535016 Min -0.1296003 38

Si ze 3 Mean 0.0522613 Max 0.127440013 (Thc Biggcst) Std . Dcv . 0.05393533 Min -0.07065668 2

A hypothesis in this research was that the year of the announcement

anticipatcd the size uf thc curnulative abnonnal return; Thi.s looked for higher CAR

124

values for those years where the undervaluatitrn of the rate of interest was higher due

to the undervaluation of the exchange rate. ! recall that Mexico undervalued the do llar.

in terms of the purchasing power parity theorem). This situation was hypothesized to

diston the capital market and to stimulate the debt issuing in the international

financia! markets. As the hypothesis suggested we expected higher number of

alliances and also higher values of CAR for the years closer to 1994 bue not that year

where uncertainty already distoned this stimulating behavior.

As we can see in the following table. there is a tendency for alliances to

increases the closer to 1994, except in 1992 when devaluation of the exchange rate

accelerated. Also, the number of alliances increased as well as the CAR results as it

was hypothesized.

The higher average CAR was gotten in 1993 and in 1994 with 9.6% and -l.39c

respectively. These two years were characterized by low rates of interese and high

undervaluation of the exchange rate. This suggests that Mexican foms increased their

debt claiming altogether with the relatively fixing of the peso. A common practice

emerged: to issue debt in the internacional market and bring the money to Mexico to

invest it in Cetes or Bolsa or probably to invest it in buying other companies for

restructuring purposes (and reselling?).

For the purpose of chis thesis. the distonions of the capital market created

ad\'antages for the Mexican Bolsa as liquidity was abundant. This favorable

conditions for the Bolsa increased the sensitivity to ove1Teact to announcements such

asan Alliance ora Merger or Acquisition.

What this work is suggesting is that the high CAR values obtained in 1993 and

1994 to alliance events are not easy to replicare. Ir would be necessary the presence of

abundant liquidity in the financia] markets to allo\\' pai1icipants to invest rapidly with

an important announcement. This affirmarive sentence will be validated for the

following years after 1994 when weaker C-\R effects are expected.

125

Afio de Fusión Emisora Car -4 +8 # 11. .. Max/Min Values

89 ALFA 0.00(118565 1

Afio Je Fusión Emisora Car -4 +8

90 .-'\PASCO -0.03097248 1

Afw Je Fusion Mean -0.0016282 7 M:L\ 0.09156

1991 Std. Dev. 0.068762 Min -0.102896

1992 '.\lean 0.00903315 6 Max 0.081066

Std. Dev. 0.083408 Min -0.1167724

1993 '.\'lean 0.095907 13 Max 0.336419

Std. Dev. 0.113176 Min -0.0699

1994 Mean 0.04290902 13 Max 0.18849273

Std. Dev. 0.08693662 Min -0.12960034

1989 - 1994 Mean 0.04533976 40

As we can observe in the precedent table, not only the number of J.lliances but

alsn the size of CAR and its significance is increased the closest to 1994. 1l1e best

year for these att1ibutes was 1993, may be the besr year for the recent economic

situation (in this year the rate of intlation had decreased to one digit. the economy \\·as

grnwing to a rate higher than 5%, the rate of interest set at only 99c. Nafta was a

promising figure, Mexico applied for the OECD countries, and politically stable).

It is interesting to note that as we realized in the last part of the em pirical

review. the economic situation of the country work.s as a l'v1ood \·ariable. very

impo11ant for predicting alliance cases and CAR results.

Regarding the kind of alliance and CAR effect, we can observe in the

following table that Acquisitions got higher stock reacrions compared to mergers and

joint ventures. 11üs was anticipated in the hypotheses as it \\'J.S suggested that

acquisitions absorbs not only the price effect on the bidding füms but also on the

target. so severa! researchers have concluded their CAR effect is higher than the one

that accounts only the effect on the target firms. This rnnfirms what we ;mticipated in

the hypotheses

126

Cumulative Abnormal Rcturn by kind of Alliance -4,+8 days pcriod

Kind of alliance Mean/Std De Car. Max/Min Car

Acquisition Mean 0.076858 Max 0.336419

SLd. Dev. 0.1118(1892 Min -0.1028961

Merger Mean 0.0239521 Max 0.18849273

SLd. Dev. 0.08462416 lv1in -0.1296

Joim Vemures Mean 0.0269574 Max 0.058599

Std. Dev. 0.05407315 Min -0.035479

The results are also consistent with the paragraphs that related the economic

situation to the number of alliances and to CAR size. What follows is to confiI111 if -

films effectively were bringing money from outside at "distoned" rate of exchange

and investing that money in buying undervalued companies. To do this, they would

issue debt in undervalued dollars to buy undervalued assets expecting these to revalue

with the alliance or acquisition.

Finns that did that -and did well, except for a lack of hedging-, must haw two

accompanied behaviors: lower tobin, s q ratios befo re the alliance compared to after

the alliance and also lower debt ratios in a before/after alliance comparison. In both

cases data shows a positive test: the average q ratio for a quarter befare the alliance

was 1.51 while debt to total assets 5.11. After the alliance. these two a,·erages

changed to 2.21 and 6.1 respectively.

Jensen (1986. 1988) argues that corporate assets were underntilized by the

managers, and restructming releases previously unrealized value by redeploying the

assets to higher-valued uses. On the other hand, the efficient market hypothesis

faithful point a finger at the füm' s entrenched management. They hold that the reason

a restructuring results in higher stock prices is management's inability or

umvillingness to allocate the firm's resources to their highest-valued uses, which in

man y cases means paying higher di vidends and reducing interna! investments (ivlartin.

John. 1991).

127

In the hypnthcses. it was postulatcd that unrelated allianccs (i.c. tirms not

necessarily complementary in their main economic activity) would get higher CAR

than non related firms. The "reasoning was not a higher synergy in terms uf learning.

clients. suppliers. employees, and so 011, but deeper undervaluation uf target assets.

better leveraging conditions and higher cost reduction. The reasoning to hypothesize

this was the theory supp011ing most of the Mexican alliances occurring during 1989 to

1994 (i.e. financia! globalization plus peso overvaluation causing cheap availability of

funds from externa! sources to direct them to buy other finns assets or stocks). Thus.

the less related the firms were, the deeper the assets undervaluation C<)U)d be present

and thus the higher the abnonnal pe1fo1mance after the alliance.

As the following table shows. unrelated firms pe1fo1med on average. much

higher CAR than related finns as the former got 11.2% CAR while the latter 2.9%.

This big difference is valid for those years where liquidity seemed to be abundant ami

thus have low generalizability for other years as 1995 and 1996.

Cumulative Abnormal Return for Related and Unrelated Firms -4,+8 days

period

jKincl of Firm

Related Mean

Firms Std. Dev.

No Relatcd Mean

Firms Std. Dev.

Mexican Allying Firms 1989-1994

CAR Max/Min

0.02868193 Max

0.07511727 Min

0.11197112 Max

0.14342168 Min

CAR

0.18849273

-0. 12960034

0.33641867

-0.069903 I 8

Leveraging is probably one of the most important detennining va1iables that

explain the presence of alliance events and CAR behavior in Mexico for the period

under analysis. As Rahim Niazur (1994) suggested. for the stocks of the high financed

firn1s. data shows significant positive correlation between their cumulative abnonnal

return around the announcement day and the post merger accounting variables. For

128

thc luw financed firms this was not true. This implies that levnaging was most

uulized for acquiring non related assets. undervalued. to overperform the market. In

our sample of strategic alliances where the cons(Í\idations predominare over mergers

and acquisitions. we validare the pattern provided by Niazur.

On ,l\'erage. financia\ accounting pe1fo1mance* of consolidations nses after

the event. for merging foms the accounting performance imprn\·ed after the

annllLmcement. but less than consolidations. 1..eYerage in our sample increased

significatively: for high leveraged firms if consolidations, accounting petformance

im pro ved less than in low leverage firms. 1 *fi nancial accounting performance was a measure of severa! financia! ratios such as

PIE. Book/Mket value. D/V. AE t= -3.+ 1: etc.

This pattern seem to ratify that there was an expans10n of sorne companies

O\'er other companies usmg diverse mechanisms such as high le\·erage to buy

unJervalued assets.

Higher leverage increased risk for the banks and other creditors. as well as

em ployees and probably customers when the 1994 crisis carne to the alliances and

tonk from the market what it had anticipated. Comell and Shapiro (1986) pointed out

that shon run profitability of firms going to restrucnuing programs increases if they

mc1\·e quickly cutting informal contracts. The shareholders' gains from that financia!

resrructming come at the direct expense of the füm 's creditors. or results from the

breJ.k.ing of implied contracts with employees, customers, or other stakeholders of the

fi1111. Sorne empi1ical evidence. moreover, has been developed supporting the

contention that bondholders often suffer from financia! restructuting (Martín, John.

1991).

Horizontal or unrelated alliances were in the literature found to affect 1ival'

returns through severa\ channels. The "bidder signaling" hypothesis is introduced here

· "li11ancial acrnunlin~ pcrfor111a1HT wa, a llll">LSUrc ol' senral financia! ralios such as l'/E. Book/\lkl'I value. D/\'. ,\E l= -3.+I; ele.

129

to demonscrate that bid price signa! infmmation to investors reganling the quality nf

the bidding firm's management so consilkring plausible that this signa! affecc che

stock prices of the bidding finn's competitors.

This was postulated in the methodology as a \'alidating test. so a sample nf -1-0

"competing" fiims was selected randomly to analyze if there was on them some CAR

effect when their main competitors were creating an alliancé with someone else.

We got in this exercise a negative average CAR of -2.3% significant at the 1 C.:-1c.­

IeveL so validating what it was hypothesized. that alliance events are accompanied by

positi\·e CAR in the merging firms and negative CAR in their compecitors. Hü\\'e\·er

this does not allow to conclude that there exist sorne redirection of returns from the

non allying firms to the allying ones.

Following Tomlin Jonathan Truman (1994) the precedent findings suggest that

examining rival stock reaction is capable of providing new evidence on the role of

alliances quite apan from their compecitive consequences. This also recalls what

Drucker observed regarding the differences between value creation and value

distribution insinuating that alliance announcements, as other announcements.

distribute more value than create it. 20.- In terms of their financia! performance.

higher abno1mal returns were obser\'ed in: higher le\'eraged firms after the event: less

profitable firms befare the event: less growing firms. in tem1s of total assets growth.

before the event; more undervalued fiims (in terms of their Tobin's q ratio) before the

event: higher cash flow before the event: and better financia! performance after the

event.

Also interesting, the high CAR values coITesponded to the finns with more

press news before the announcement: the more successive strategic alliances the film

had: and the more family oriented their corporate control constituted.

The author thinks that these elements although interesting. are only descripti,·e

of whac happened in Mexico during 1989 to 1994 but have low forecasting pmYer.

Fm inneasing this. the presence nf che nrnod \·ariables. i.e. the leve! of the interese

130

rate ancJ the foreign exchange as well as the openness of the international financia!

markct to the Mexican firms has to be present.

After two years of the alliance announcement. the firms that best outpe1fo11ned

Juring this announcement they no longer continued outperfonning. This proveo the

hypothesis that stock retums during strategic alliance events draws a short run fim1

performance ancJ nota long run performance. Thus, CAR results Joes not Jraw any -

picture of what coulcJ be the expected performance of those firms in the long run.

A multivariate statistical multidiscriminant model (MDM) was preferred for

desc1iptive and predictive purposes by its large power in assessing the statistical

Jifferences between high pe1foll11ance foms to low perfoll11ance ones. The MDM

relatecJ CAR with financia! pe1tºo1mance attributes befare, dming, and after the

merger, controlling for size and economic activity.

The multidiscriminant model showed the following results:

Among severa! variables that were used to discriminare in the sample, market to book

value (a proxy of Tobin's q) was significatively different and it worked well in

discriminating the behavior of the Cumulative Abnormal Return. This is seen in the

size and significance of the Wilks 'Lamba statistic (.87367 and 95% significance).

Other variables used were Price/earnings ratio. Debt/Value ratio, Size of the firm,

Relatedness of the firrn, Year of the announcement. Family orientation of the Council

of Shareholders. and Market concentration as a proxy of monopoly power.

Wilks' Lambda (U-statistic) and univariate F-ratio

with 2 and 44 degrees of freedom

Variable Wilks' Lambda F Significance

CAR .97352 .5983 .5541

LEY .99775 .0496 .9516

LIBR .87365 3.1816 .0512

PU .98044 .4389 .6475

FP .96669 .7581 .4746

131

CAR means cumulative abnormal return; LEY rneans leveraging; LIBR means rnarket

to book value; PU means price/earnings; FP means Financia! Performance.

Market to book value (LIBR) was very significant in pan due to its high

association with other financia! variables as most finns in Mexico keep book value

actualized enough, principally for tax purposes and valuation objectives. However.

this can also imply that the other vectors could be misspecified. (See the annex 2 for

more detail).

Looking at the covariance matrix and the correlation matrix, it is notorious that

CAR is highly associated with leverage and price eamings. Leverage, with market to

book value and Financia! Pert·ormance. Market to book value with price earnings and

this latter with Financia! Perfonnance. The advantage of MDA is that it lets statistics

to work by themselves in finding the best association measures as well as the best

differentiating measures, obtaining a good map of how firms associate each other in

terms of their data and not in a predetermined basis to explain success or failure in

terms of the cumulative abnonnal retum. In this work this was done in three stages

each for a quarter of ayear, befare, during, and after the alliance announcement.

POOLED \VITHIN GROUPS COVARIANCE MATRIX

(with 44 degrees of freedom)

CAR LEY LIBR PU FP

CAR .1930

LEY .0337 .0557

LIBR .0202 .0342 .2831

PU -3.1655 -.3153 -5.7180 927.9772

FP - 115944. 2628 -185173.8715 -224774.6613 24322891.9882 6675499812449

CAR means cumulative abnormal return; LEY means leveraging; LIBR means market

to book value: PU means price/earnings; FP means Financia! Performance.

132

POOLED WITHIN GROUPS CORRELATION MATRIX

CAR LEY LIBR PU FP

C.-'\ R l . 00000

LEY .32528 1.00000

LIBR .08653 .27281 1.00000

PL' -.23656 -.04386 -.35278 1.00000

FP -.10216 -.30377 -.16351 .30903 1.00000

The MOA model found t\vo canonical discriminate functions using the Jirect

method of including all variables passing the tolerance test. From this. we gc1t the

Fisher's linear discriminate functions or classification coefficients in which LE\. and

LIBR absorb most of vaiiance.

TRI MES -1 o 1

C.-'\R - .0726528 - .5418889 -1.7303423

LEY 4.9108413 6.5130114 8.5992810

LIBR 3.3871115 2.1981306 8416221

Pu .0419260 .0327751 .0054510

FP .0000001 .0000002 .0000004

(Cnnstant) 3.8645465 3.3660079 3.2018500

Also. it is observed that the selected variables form a function that explains

mnre variance than each variable by itself. Toe two main variables that explain more

variance are LEY (leverage) and LIBR (market to book value). The theoretical

rebtionship between these two \'ariables is not easy to establish i.e. what happens to

market value orto book value when leverage changes and viceversa. The interesting

thing is that as firms approach to the allying event, they differentiate eJ.ch other in

terrns of leverage or in te1ms of LIBR. Cash flow and price eamings keep related to

133

these last two, at least statistically. Thus, most variance can be accounted here by the

two canonical functions if the Fishers coefficients are 1ight.

Similarly to what Lehn and Poulsen ( 1989) found support for the Jensen (1986)

free cash flow hypothesis in te1ms of the LBO formations -founding evidence of a

significant relationship between undisuibuted cash flow and a firm 's decision to go

p1·ivate-, this thesis found that there exist a significant relationship between leverage

ami LIBR associated with cash tlow. and their signalling to the market depending to

the rnoment and the economic environment when the decision is taken.

The theoretical relationship between the two variables was said to emerge from

their combination and its signaling to the market. For instance. high leverage firms

with low LIBR at time -1 (a quarter before the alliance) would be signalling positive

growth perspectives as the higher debt prepares for the coming alliance at time O in

which new assets are acquired and revalued. The low LIBR becomes the growth

signa!, a measure of undervaluation or a correction of a pre\·ious ove1investment in

the allying finns. Toe canonical functions absorbs this behavior related with cash flow

and price/earnings.

On the contrary, high leverage firms with high LIBR at time -1 are not seen as

good market opportunities as they already have anticipated the price effects of

leveraging and thus higher debt is not necessa1ily seen as good signa!. Thus, there is

no more growth opportunities, undervaluation. or previous ove1investment. So the

alliance announcement gives lower CAR effects.

Consistently, low leverage firms with high LIBR gives higher positive CAR

results as the alliance is seen as the proof that the low leverage firms are doing the

appropriate thing with the acquisition and can expand. On the contrary, low leverage

fiims but with low LIBR (apparently a jewel for banquers and investors) is not

necessarily seen as a good market oppo1tunity because the low leverage can be

signalling low growth opponunities and high 1isk. However. if low LEY and LIBR is

134

acrnmpan1ed with high cash tlow and noL low P/U (price earningsl. a good market

opportunity is identified.

This corroborates what ú was postulated in the hypothc'ses ami in the theoretical

frarnework. that stockholders of Mexican tirms reacting to the 1988-1994 economic

model. felt stimulated to increase debt burden to severa! possible things: rebuy shares

to take his money out of the companies to buy another companies principally

horizontal strategic alliances. This issue has much to do with the corporate

governance of the firms, the expansion of the economic groups in the country. and the

agency problem this expansion relates to .

This reminds the explanation given by Jensen Michael (l 986) answering the

question of why do stockholders want to increase the debe burden? "Although che

conventional wisdom says that leverage is bad and sound financing equates with a

substantial equity commitment, the evidence indicates otherwise ... Michael Jensen

( 1986) offers an explanation. through his "free cash flow hypothesis." He observes

that extreme use of debt substantially erodes management power over the deployment

of cash flows generated by a firm 's mature operations. His argument goes as follows:

a c.lramatic increase in the firm's use of financia! Ieverage. with the proceeds used to

repurchase shares, leaves the firm with short position.

Not only shareholders are stimulated debt burden but also Managers who have

a tendency to expand their operations as salary, compensations and bonuses increased

altogether with power, experience. and social relations. Shareholders reduce

managerial discretion over che reinvestment of che firm' s free cash which 1s now

monitorec.l by bankers. Managers now administer more resources (Bankers') and

stockholders get their money out of the firm enjoying to have initiated a business that

now does not require his funds so they can invest them in other firms or uses.

Williamson (1988) offers a complementary argument. contending that .. debt"

ami "e4uity .. should not be ,·iewed as financia! inst11.1ments. but instead as govemance

structures. Thus. a leveraged recapitalization should not be viewed as a mere ··paper-

135

shuffle" dnne for tax purposes ... debt service impose significantly more restrictions

upon management. When mature, fairly stable activities are involved. Williamson

argues that investors prefer- and are willing to pay a premium to get- a govemance

structure based upon strict rules. This lessens the risk of surprises that might arise if

the management continued to excercise substantial discretion (Martin. J. 1991 ).

The multidiscriminant analysis facilitares the combination- nf the quantitative

and qualitative considerations regarding the motives and expected consequences of

establishing a merger, acquisition, consolidation. joint venture or anyother alliance as

they are absorbing the interna! corporate control motives with the possibilities to do

so in each moment the alliance is documented. Externa! motives (macroeconomic)

complement with interna! (growth opportunities. financial pe1fo1mance, agency

considerations and corporate control). This behavior is interpreted in terms of

simila1ities and differences regarding the financial indicators, the industrial activity,

the kind of the firm. its degree of relatedness and the other variables already exposed

and get results wich can be associated by their variance in a multiunction basis, a

combination of severa! variables everyone acting in a standardized way. The

standardized canonical discriminant function coefficients which are shown in the next

paragraphs will get the visual mapping of this natural association among foms by its

effect on CAR and the use of the variables determinant in explaining their variance.

STANDARDIZED CANONICAL DISCRIMINANT FUNCTION

CO EFFI CIENTS

Func 1 Func 2 CAR .50118 .29280 LEY -.58210 .23581 LIBR .90029 -.56413 PU .76935 .60588 FP -_50562 -.51930

The structure matrix shows a negative correlation between LEY and Func 1

differently to the positive correlation between LIBR and Func l. The pooled \Vithin-

136

groups correlatiuns between discriminating variables and canunical discriminant

functiuns (variables ordered by size of co1Telation within function) ahibits the

following results. altogether with the unstandardized canonical discriminant function

coefficients. This ratifies what we were expecting in the hypotheses regarding the

complementary between LEY and LIBR and its negative association in explaining

CAR behavior (through the two canonical functions).

Canonical discriminant function coefficients and unstandardized canonical

CAR LIBR PU FP LEY

discriminant functions coefficients

Function 1 Function 2 Function 1 Function 2 .25939* .23042 CAR 1.140955 .59611 -.60330* LIBR 1.6920270 -1.0602488 .20246 .56480* PU .0252554 .0198892

-.28944 -.34138* FP -1.95695991 E-07 -2.009927 l 6E-07 - .05362 .30833* LEY -2.4672165 .999495á

denotes largest absolute correlation between each \·ariable and any disc1iminant

function. It is interesting to note how the two canonical discriminant functions

evaluated at group means (group centroids) changed in the event quarter, reducing

strongly in terms of the function 1 and increasing in terrns of the function 2. This

effect is related with the abnorrnal recurns. Their effect is absorbed by the centroids

other than the variables forming the functions 1 and 2.

Centroids Group Function 1 Function 2 -1 .69094 -.09642 o .13906 .14427

-.78681 -.05388

In the Annex 6 the graphs show the mappmg of the centroids and the

disc1imation of the firms on space. One can see how the centroids were moving

toward group O (which means quaner O or the quarter of the announcement) in terms

of both functions to afterwards come back to che approximately the same value in

terrns of the function 2 but somehO\\. far from the functicin l (composed by the

137

relationships absorbed by LlBR ami the nther variables). It labels function l as

"npponunity growth" and the function 2 as "governance leverage·· .

The finns of the merging sample are distributed by the f\·1DA in relatinn to their

value in the two functions. The finns located to the left of the rnigin are not seen by

the market as having growth opportunities. The ones to the right haw growth

opportunities. Similarly, the fim1s located to the left of the function 2 are ,wt seen as

having health leverage (in terms of debt equity ratio, price eamings. cash flow. and

others such as year of the announcement. family composition in the council of

shareholders, relatedness. monopoly power and so on). The nnes to the right were

seen by the market as doing good leverage (they are signalling the correct decision) as

represented by the function of the cornposed index of the qualitative and quantitative

variables included in the multidiscriminant model.

Dividends were excluded in the multidiscriminant model because consistently

with Bagwell and Shoven (1989), as well as Shoven (1986). we neither found

evidence concerning the relationship between dividends and cash flow. Instead. we

found higher relationship between cash flow and leverage LEV so being absorbed by

the canonical function 1. Following Shoven, dividends are not longer the dominant

source of cash distributions to stockholders. In México lO\\. is the CAR effect to

di vidends payments thus. acquisitions and share repurchases take precedence.

Bagwell and Shoven (1989), as well as Shoven (1986), provide evidence that over the

period from 1970 through 1985. in the US the total cash received from acquisitions

and share repurchases steadily grew, until it exceeded dividends. In México. a similar

behavior is found so decreasing the imp011ance of dividends in explaining cash flow

utilization (lispinoza, Manuel. In progress).

Analyzing the data with the cumulative abnormal rerum as a disc,iminant

variable (if high abnormal retum. successful firms, and if low abnorrnal retum

unsuccessful finns) and the financia! va,iables as independent variables, it is

obscrYed :

138

The disc1iminant analysis supports thc conclusion that the key variable in

explaining the differences on Cumulative Abnormal Retum is found principally in the

· adequate management of the function 2, composed by the measurement of the price to

book value of the firms during the alliance announcement.

Firms at the event that have a .successful ratio of price per unit of earning.s to

leverage will tend to get higher cumulative abnonnal retum associated with a higher

value of function 2. On the other side, foms with high price per unit of earnings to

leverage during the event but low price to book value (functiL1n 2) will not get as

much cumulative abnormal retum as in the first case.

Function 2 represented by a measurement of the ratio of market p1ice to book

value is the most important variable in differentiating the results of the cumulative

abnormal retum of allying firrns. Firms with high price per unit of profits and debt but

with low Libr (low market price to book value) will tend to fail in getting cumulative

abnormal retum. This kind of firms show financia] pe1formance vaiiables more

homogenous among the firms of this group and very different from the other groups

of high and medium cumulative abnorrnal return (See table 6.5).

Finns that reponed medium cumulative abnormal retum (Group 2. in the graph 6.5)

are better disc1irninated by Libr (market to book value) but low significance regarding

their differences in terms of price per unit of profit and leverage.

Firms with high cumulative abnormal retum are very \\'ell differentiated by

Function 2 (Libr) and they can take any value between the range of the price earnings

per unit of leverage.

As we can see in table 6.5 groups with the lowest high cumulative abnonnal

return (Group l) are very different from firms of group 2 and 3. This means that we

can attempt to forecast easier which firrns will fail during the announcement to get

139

gonu cumulative abnonnal return. More difficult seems to be to discriminate between

firrns of rncdium cumulative abnorrnal return to firms with high curnulative abnormal

return. The only significant difference seems to be the values on Libr or market to

book ratio function 2 in the disc1iminant model.

Summarizing the difference between successful firms m alliance

announcements and unsuccessful firms is that both show high price earnings per unit

of leverage but the former with high market price to book value and the latter lower

price to book ratio, and the ones with low market p1ice to book value have medium

success no matter which value has in p1ice earnings per unit of leverage. This can be

shown in the following table.

Table 6.6 Critical Factors to Success in Alliances

Mexican Strategic Alliances 1989-1994 CAR (-4+8 days period)

High P!E/L

Low P!E/L

High Libr

Succesful

U nsuccesful

High P/E/L high price eamings ratio by unit of leverage

Low P/E/L high price earnings ratio by unit of leverage

Low Libr

Medium Success

Medium Succes

High Libr meaos high ratio of market to book values weighted by other

financia! performance

140

CONCLUSIONS

The Mexican Stock market reacted efficiently in a semi strong form to alliance

announcements registered from 1989 to 1994. The results show that this market

experienced a significant 4.5% increase in the cumulative abnonnal return during the -4 +8

days event pe1iod. This result was found to be consistent with other studies regarding

expected bidders effect. The stock prices of the allying fiims reflected public available

inforrnation -financia! and market-. However, it was found sorne unexpected abnmmal

return behavior since thirty days befare the official announcernent depressing stoclc prices

accornpanied with a higher trading volume also significant. This behavior was considered

to be representing the existence of sorne inside trading though this was considered small

and more related to press news than to speculation. Lack of consistent infonnation

regarding the personality of the participants dming those thirty days befare the

announcement, inhibir better results.

Fi1ms that established an alliance -concentration, rnerger, acquisition- and in

which an interchange of stocks was involved, showed a rank of extraordinary returns frorn

-13% in Gafin to 39% in Synkro A. The differences between the high abno1mal pe1fo1mers

and the low abnormal performer was found in a combination of variables -financia! and

organizational as well as with respect to the market-. Some identified patterns were:

financia! firms experienced higher abnmmal returns: less big fiims also got higher

abnonnal returns: acquisitions and concentrations got higher abnormal retums than

mergers and joint ventures: unrelated alliances performed better than related ones; levered

alliances also did better than less levered firms: firms that were outperforming the others in

te1ms of financia! results got higher extraordinary retums du1ing the announcement. and

last. no significance was found regarding the shareholders - managers governance

diffcrences among firms.

141

The discriminant model allowed this research rn conclude that there exist some

financia! differences accompanied with abnormal return that in sorne sense anticípate a

merger event. However, the small sample size and its low significance leve! does not

obtain conclusive results. What the discriminant analysis obtained \\'as a gnod predictor of

when an alliance announcement will end in higher abno1mal pe1formers compared with

low abnormal performers. Success expects to finns with high Libr and high price eamings

to leverage ratios. This result moderated by the economic situation of Mexico during 1989-

94.

Table 1

World Flow of Resources

(in billions of dollars)

YE.\R TOTALBANK TOTAL TOT.\L FLOWTO

FLOW AMOUNTOF UNDERDE\'ELOI'

IIONDS ED COU:",TRIES

1983 170 77 247 31

1984 183 110 293 11

1985 276 168 444 3

1986 538 226 765 2

1987 803 181 984 21

1988 559 227 786 -9

1989 820 256 1076 5

1990 939 315 1254 7

1991 810 444 1411 10

1992 904 653 1557 11

1993 908 786 1694 13

r--hi~ 800 436 1236 11

Sourc..·· lm.!rnalional ~foueUU')' í-und. ln1emalional Capital MarkeL<;, Developnii!nl and Prospcc~. \\\si"unghm. D.C.. ~1ay 1995.

FúTc!I~

B~)nd.s Dcvi:!loped counuic!s ~ ... ·el0pmg c011ntncs

lnt.?rnallvn :i.lOrgJ.niza o.vns Otl!o!rs

Eur0l-0nds Oo:!\c\v~d C,)•llltnO:s

D.:vel0pin.~ c,mutn.:s lntC'1na1 Or~

Oillo!rs

D..-vel,,~d

túllllln<.'S

D..-v<![ .. ,pm~ c,rnmn,:,s lntcrna11c,nal 0:-.:111111..1:kn

1985

31229

19736

1815

9350

327 136543 118194

8543

31:?-i lf.7772

137931

><-l97

I iB9J

1986

39359

29161

1790

8360

48 187747 172020

2989

10488

~250 :?27106

2011~ 1

4779

198 7 40252

30990

1480

7461

320

140536 125293

11320

1562~3

393,¡

Table 2

International Bond Issues*

(in million of dollars)

1988

48273

37111

2185

8307

670 1788869

161190

4074

11393

2213 2271-13

19~301

1989

42932

31755

1843

8172

1142 212853 192653

2~71

13451

387R 2.557X5

1990

469(17

36316

1373

680 181870 152606

205-1 l

48R, 22'b'7i:

1991

50215

1298

9287

720 235-)3-1 167934

3878

5725 2-N360

57 30

316-53

1992

53860

51935

1428

11236

983 24~02 173904

4103

31296

5839 263758

284033

f.129

36385

229~ .......... l.?.~.'-· ............ ~~~~- . ...... )~;!! . ....... 55i;,: !:',!)\ 5 673-1

1993

59421

57235

1857

12835

1167 256314 183641

4428

35K24

6172 277444

Jl75K7

6528

7)54

1994

65278

62531

2745

13732

1302 263083 19:2583

3904-I

7-122 290533

3'.JI 305

7120

>il[))

142

Table 3

Intcrnational Markcts Loans by most important instrument,;;

(in percentagcs)

In 1990 1991 1992 1993 1994

strurncnt

Fixcd-rate 70.00 67.1

bonds

Fluating-ralc 16.10 13.20

llül~S

Convertible 13.-10 16.4.80

ilonds

Other bon<ls 00.50 3.4

Total 100.00 100.00

62.00

22.-+0

11.SO

-1.70

100.00

62.00

24.SO

10.20

3.00

100.00

61.00

25.00

11.80

3.20

100.00 ~~~----~~~~-~~~~~..L..~~~~-~·~-~~~~-'~-~~~~--'-~~~~-~

Sl)\1rn::\\',,rld Ernnvniic and Fmancial Survcys. lutcmauvnal Cap1ul ~tarkcis. l)::·.e10pmnc1 ancl Prospects, lntcr.-;::..:.:..::c.J.l ~fonewy Fund. \\ ¿:,hm~wn. D.C .. ~lay 1995

Tahlc 4. Nct Intemational Flnws of Stock, 1991-1994 (in billions of <lollarsl

1991 1992 1993 1994

!\'\'ESTOR

C nit~d Sta tes 24.2 25.7 26.6 19.7

Japan 22.5 25.2 23.2 17.9

Cnited Kingdom 35. 7 37.-1 41.2 19.8

Continental 23.6 26.4 19.8 16.4

Euro pe

Res! of !he world 4.5 2.3 2.8 1.40

ISSCER

C nited States 26.8 32.5 34.6 21.5

Japan -1.7 2.-1 4.5 3.0

l'niled Kingdom 3.7 -1.7 -1.3 3.1

Continental 51.2 57.8 63.0 42.l

Europe

Rest of thc wor!d 31.3 37.9 39.0 28.6

TOTAL 117.7 135.3 139.2 98.3 ..

S<..1urt·c: World Fc,,fü~nuc ar.c.J hnanc1al Survcys. lnlcmauunal Cap11:i.i \farkct.s. De-.dopmeni and Prospccis. hHc~::.....·..: .·:~ai ~1onct:i.ry l·und. \\ o:.lun~1on. ü.C.. May l •NS.

143

me:-.: 5.

'llJ'L: S. 1

- 3 .0

] . o

2.0

1 .0

. O

-1.0

-2.0

.. 3. O

.. 3 . O

Canonical Discriminant Functi on 1 - 2 .0 -1.0 .O 1.0 2.0 3 . 0

22 33 22

3322 3 3 22

3322 3322

3322 3322

+

21 21

21 21 21

21

+ 21 21 21 21

21 + 3322 3322 + 21

332 322

21 21 21 21

+

+

3322 3322 *

*3322 21 33221

31 31 31

31 31 31 31 31

+

+

3322

+ 21 + +

+ 21 + +

+21 * + +

+31 + +

+ + +n + + 31 31 31 31 31 31

-2.0 -1.0 .o 1.0 2.0 3.0

144

144

Fi .~11rc .'\.2

F

l J

n \,

o

n

)

1-15

C'D1Cni c:d D s a i rri rcnt Functi ms

MERG: 80JO-l 4

So

yr, k ro

3 •

;¿ •

Gco r ~o Mu<.le r riu O

1 -4 . o 1 ':i ,c:r Gqtotx llunAcci'

Ge µec () LS&1ex ( 1 1 '") b (} 11:rn:;oC, Gfh

;~·., ,·.,: O A¡,w .co (; (i11 v<: r

Ccn ln>id

(>lro

O. Gscrf,n

E8o -1 •

Accebu o Pun dcr o ('•) '····' Ga..oQntrdd

¿ •

J ....-~~~~~~--.r--~~~~~~-y-~~~~~~--,r-~~~~~~--.--~~~~~~---,, O Ga..o-1

o L J 4

Ftrnim 1

145

i ·Í)c' l llC ) .1

('1T)mim Disairrinmt FLJndimc;

MERG = Gra.JOÜ 15 -

F

u

10 i Ponder n o e Synkro

o t

5 •

o 1 Cifra

GCorso o o EckQ\ n

o o ~ Cemex va0sa '· .. o

o Situr

? I eisa Accel so o

' ~ Apósco -.,)

Modcrr1G {)

-1.0 - --1.5 -1.0 -.5

FtJndim l

O.O

146

Ge0ec

GGemex

CFB o o O CFinver

146

GSerlin o

Ba()cci

GrnoCmtrc:id

O GrnoD

.5 1.0

1 :igurL.: 5.-1

F u n e t 1

o n

2

Canonical Discrirninant Functions 4 o

3 •

2 •

1 •

o •

-1.

-2 • o

o

o

;{"\ ' d

o

o o

o 00'6° ~-o ..-,. e, GroQo ~ ,.,.- "

&o~· .. (,;fi C-«. ~roo -1 P

('i <:v. "7> ,~O o ( /'i. ~

O' ~) o o o o o

o o o

-3 ~---------.-------------.----------:.:-----------.--------------------------------J ,-3 -2 -1 o 1 2 3 4

Function 1

147

1-t7

O Group Centro ids

o Group 1

o Group O

0 Group -1

Syrnbols used in territorial map

Symbol Group Label

1 2 3 *

1 2 3

Group centroids

Territorial Map • indicates a group centroid

Canonical Discriminant Function 1 - 3 . o 1 - 2 . o -t. o . o I l. o 1 2. o 3 ·1º 1 1

e a n o n i e a 1

D i s e r i m i n a n t

F u n e t i o n

2

3.0

2.0

1.0

. o

-1. o

-2.0

3 23

233 2233

223 233 +

223 233

223 233

2233 223

+

+

+

+

233 223

233

+

+

+ 331

311 331

3311 311

+ 311

331 2233 3311

223 311 233 * 331

223 + • 2331*

21 21 21

+ 21 21 21 21

+ 21 21

21 21

21 21 21

+311

21

+21

-3.0 -t- 21

3 331

3311 311

331 3311+

331

+

+

+

-3.0 -2.0 -1.0 .o 1.0 2.0 3.0

311

+

+

+

+

.... .;;,. 00

149

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ASACO GRUPO FINANCIERO, S. A. DE C. V.

Authorization Date: Mar. 11, 1992 Authorization No.: 102-E-367-DGBM-111-912 Ticker Symbol: ABACO Head Office: Montes Rocallosos no. 505 - 66260 - Garza García, N.L. Chairman: Jorge Lankenau Rocha

No. of Employees: 4899 No.ofBranches: 181

Background

166

Abaco Grupo Financiero was formed in 1992. lts main subsidiaries are Confía (multiple bank) and Abaco Casa de Bolsa (investment bank). The remaining subsidiaries provide services of foreign currency, factoring, financia! leasing and insurance. In the last two years, the Group implemented its universal bank strategy and reinforced its international presence. In December, 1993, through Abaco Casa de Bolsa it acquired 54% social capital of Rodman & Renshaw Capital Group, lnc., a financia! company headquartered in Chicago.

Main Officers Jorge Lankenau Eduardo Camarena Reynelle Cornish Jorge García Francisco Quintanilla Sergio Riojas Fernando Valdés Frederick Turner

Dir General lntl Area Branches Legal Controller Systems & Communications Planning Corporate Relations

No. of shares outstanding Serie A

Dec 93 110,759,953 41,501,739 47,005,390

199,267 ,082

Serie B Serie c Total

Main Affiliated & Associated Confía (99.94%) Abaco Casa de Bolsa (99.99%) Aba Divisas (99.99%) Aba Factor (99.86%) Aba Renda (97.57%) Aba Seguros (99.83%)

Business Banking Stock Brokerage Foreign Exchange Factoring Finance Leasing lnsurance

ALFA,S. A. DE C. V.

Established: 1974 Listing Date: Aug, 1978 Ticker Symbol: ALFA Head Office: Ave. Gómez Morín, 1111 Sur- 66220 - Garza García N.L. Chairman: Dionisia Garza Medina

lndependent Auditor: Price Waterhouse Nature of Control: Mexican Private No. of Employees: 22,458 References: Bancomer/Serfin/Banamex/ JP Morgan/Morgan Stanley

Background

167

Alfa dates back to the last century, when Monterrey Mexico began its industrialization. Building on this foundation, we have become a leading Mexican corporation with interests in steel, food, petrochemicals, synthetic fibers, autoparts, mattresses, carpets and others.

Main Markets & Competition Alfa's companies are focused in domestica market such as: construction, textile and apparel, food, etc. In each one of the markets it serves Alfa has either the leading or the second position.

Main Raw Materials & Sources Main raw materials are: iron ore, scrap iron, paraxylene, propylene, ethylene oxide, aluminun scrap, etc.

Main Officers Dionisio GarzaMedina Chairman & C.E.O. Felipe Cortéz President- Hylsamex Armando Garza Sada President- Sigma José de Jesús Valdéz President- Alpek Roberto Garza DelgadoPresident- Versax Peter T: Hutchison M. · V-P, Corp Fin & Plan Leopoldo Marroquín M. V-P, Corp Legal Alejandro Guzmán G. V-P, Corp Human Res Juan B. Morales D. V-P. Mexico City Off

No. of shares outstanding Serie A Total

Main Affiliated & Associated Hylsamex (100.00%) Sigma (100.00%) Alpek (100.00%) Versax (100.00%)

Dec 93 173,547,596 173,547 ,596

Business Steel Food Petrochemical Diversified products

APASCO, S. A. DE C. V.

Established: 1981 Listing Date: Dec, 1981 Ticker Symbol: APASCO Head Office: Campos Elíseos, 345, piso 18 11560 México, D.F. Chairman: Agustín Santamarina

lndependent Auditor: Arthur Andersen & Co. Nature of Control: Mexican Prívate No. of Employees: 4060 References: Banamex/Bancomer/Citibank/E.M.0./0.E.C./Swiss Bank/lFC

Background

168

Grupo Apasco began operations in 1963 with a plant in Apaxco with an installed capacity of 150,000 t/year. Presently, the company operates six plants with an annual installed capaeity of 7,600,000 tons, which was achieved in October 1993 with the start-up of the plant Tecoman, Colima, In May 1993 the Ramos Arizpe plant expanded production capacity of 200,000 tons with the installation of a roller press. In December 1993 the capacity of the Acapulco plant was increased by 120,000 tons. During 1993, 3 new distribution centers were opened in Monterrey, Toluca and Puebla reaching a total of 9 troughout the country. In the ready-mix concrete area, Apasco has a 28% of the domestic market share with 83 plants in Mexico's majar cities.

Main Markets & Competition Apasco's share in the domestic cement market is 22%, and main competitors are: Cemex, with 64% and Cementos Cruz Azul, with 12%. With its six cement plants, strategically located, Grupo Apasco has a national coverage.

Main Raw Materials & Sources Apasco's shme in the domestic cement market is 22% and main competitors are: Cemex, with 64% and Cementos Cruz Azul, with 12%. With its six cement plants, strategically located, Grupo Apasco has a national coverage.

Main Officers Pierre Foidevaraux Vincent Bichet Alejandro Borchers Carlos Bühler Gullermo García Francisco Glennie Anthon Nussbaumer

President C.E.O. Vice Pres Marketing Vice Pres Plan & Devel Vice Pres Fin & Adm Vice Pres Ready-Mix Cone Vice Pres Hum Resources Vice Pres Operations

No. of shares outstanding Serie A

Dec 93 141,980,339 136,412,482 278,392,821

Serie B Total

Main Affiliated & Associated Business Cementos Apasco (99.90%) Cernen! Concretos Apasco (99.90%) Ready-Mixed Concrete

BANCO NACIONAL DE MEXICO S.A.

Established: 1884 Listing Date: Feb, 1 ~87 Ticker Symbol: BANAMEX Head Office: Isabel la Católica 44 - 06089 - México, D.F. Chairman: Roberto Hernández Ramírez

lndependent Auditor: KPMB - Cárdenas dosal, S.C. Peat Maiwick Nature of Control: Mexican Prívate No. of Employees: 33,327 No.ofBranches:686 Overseas: 12

Background

169

Banamex has 686 branch offices within the Mexican Republic; 5 agencies, 7 represeritative offices and two subsidiary bank abroad. The bank structure has 6 business areas and 6 administrtive areas. In August, 1991 it was formed the Grupo Banamex Accival, S.A. de C.V., which has maintained the leadership as a financia! group.

Main Officers Alfredo Harp Helú Chairman, Mgm Committee José G. Aguilera Medrana V- Chairman of the Board Alejandro Betancourt Alpírez V- Chairman of the Board José Canasí Azar Deputy President Jaéques Levy Seegall Deputy President Marcos A. Martínez Gavica Deputy President Manuel Medina Mora Escalante Deputy President Aiberto Navarro Rodríguez Deputy President Carlos Nuñez Urquiza Deputy President Manuel Sánchez Lugo Deputy President

No. of shares outstanding Serie A Serie B Total

Main Affiliated & Associated Arrendora ·Banamex

Dec 93 371,141,609 360, 134,204 731,275,813

Banamex USA Bancorp (100.00%) Casa de Cambio Euromex Euroamerican Capital Corp (100.00%)

Business Fin Leasing Holding Foreign Exchange Banking Services

CEMEX, S. A. DE C. V.

Established: 1920 Listing Date: Feb, 1976 Ticker Symbol: CEMEX Head Office: Av. Constitución, 444 Pte. -64000 - Monterrey, N.L. Chairman: Marcelo Zambrano Hellion

lndependent Auditor: KPMG Cárdenas Dosal, S.C. Nature of Control: Mexican Private No. of Employees: 22,865 References: Bancomer/ Banamex/Serfin/Citybank/ J.P. Morgan/ Bank of America I Chase Manhattan

Background

170

Cemex, S.A., a long with a story started in 1906, succeeded as a worldwide cement leader, competing in international level and with multinational presence. Today, the group is constituted by several subsidiaries located in Mexico, Spain, Venezuela, and the United States. Presently, Cemex is the fourth most importan! cement producer at worldwide level and ít has confirmed its position as the main cement organization in Amercan territory.

Main Officers Lorenzo H. Zambrano Treviño Gustavo A. Caballero Guerrero Ernesto Rubio del Cueto Luis Marinez Argüello Laurence Amaya Díaz Héctor Tamez González Héctor Valenzuela Loustaunau Alej-andro Pérez Gorostieta José Domene Zambrano Armando J. García Segovia

Dir., General Dir, Fin & Plan Dir Corp, Mexico Dir Corp, Mktg Dir, Pacific Reg Dir, North Reg Dir, Center South Reg Dir, Concrete Dir, lnternational Dir, Br & Corp Serv

No. of shares outstanding Serie A Serie B CPO Total

Dec 93 201,300,000 78,700,000 33,000,000

313,000,000

Main Affiliated & Associated Cementos Monterrey (100.00%) Grupo Empresarial Maya (94.90%) Sunbelt Enterprises (94.43%) Tolmex (69.80%) Tursimo Cemex (100.00%)

Main Market & Competition

Business Cerne ni/Concrete CemenVConcrete CemenVConcrete Cerne ni/Concrete Tourism

Cemex's main markets are Mexico, Spain, Venezuela, South United States, and the Caribbean. In Mexico, its main competitor is Apasco (Holderbank)

Main Raw. Materials & Sources Limestone and clay, which are extracted from deposits where Cemex has the aploitation concession. Other materials, such as iron oxide, are obtainde from externa!.

CIFRA, S. A. DE C. V.

Established: 1958 Listing Date: Oct, 1974 Ticker Symbol: CIFRA Head Office: José Ma. Castorena, 470 - 05200 - México, D.F. Chairman: Jerónimo Arango Arias

lndependent Auditor: Price Waterhouse Nature of Control: Mexican Private No. of Employees: 39,934

171

References: Bancomer/ Banamex/Serfin/Citybank/Morgan Guaranty Trust/ First National Bank of Chicago

Background CIFRA is a holding company operating in the retail sector through 264 otulets in the fields of goods and services. The group consisted of the following chains at the end of 1993: 33 "Almacenes Aurrerá" self-service department storés selling clothing, general merchandise and supermarket goods; 45 "Bodega Aurrerá" discount warehouse stores; 37 supermarkets "Superama" ; 3 hypermarkets "Gran Bazar" and 2 "Wal-Mart supercenters" ; - 7 "Club Aurrerá-Sam's Club" memebers only wholesale otulets; 31 "Suburbia" department stores specializing in clothing; "Vips" , a cha in of 106 restaurants (15 franchises) that serve the needs of the consumers with different types of foods. In order to better serve Mexican consumers Cifra has expanded its joint venture with Wal-Mart Stores, lnc. to involve all Cifra concepts. Of the total 264 otulets, 23 are part of this agreement: 2 "Almacenes Aurrerá" , 1 O " Bodega Aurrerá", 2 "Superama"; 7 "Club Aurrerá-Sam's Club", 2 "Supercenter''.

Main Officers Henry Davis Singoret President Luis Minvielle Méndez Dir, Almacenes Aurrera Juan Manuel Márquez Dir, Bodega Aurrerá Cesáreo Fernández Director Suburbia Javier López Mancisidor Director Vips Antonio Rodríguez Cota Dir, Real Estate Div Gilberto Perezalonso Cifuentes Dir, Gen Corp José María García Pérez Dir, Hum Res

No. of shares outstanding Serie A & B Serie c Total

Main Affiliated & Associated

Dec 93 2,400,000,000

800,000,000 3,200,000,000

Controladora de tiendas de Descuento (99.99%) Controladora Bodega Aurrerá (99.99%) Controladora de Superamas (99.99%) Controladora Suburbia (99.99%) Controladora Vips (99.99%) WMHC de Mexico (50.00%) Cifra-Mart (50.00%) Comercializadora Mexico-Americana (51.00%)

Business Retailing Retailing Retailing Retailing Restaurants & Services Retailing Retailing Trading

172

Main Market & Competition 78% of the commercial units are located in Mexico City and neighbouring areas, it also owns outlets in 20 other cities of the interior. Main competitors are Comercial Mexicana, Gigante, Soriana, sorne department stores and restaurants chains.

Main Raw Materials & Sources CIFRA's distribution line includes a large variety of clothing articles, general foods, foodstuffs and perishables, which are purchased from more than 12, 700 suppliers.

COCA-COLA FEMSA S.A. DE C. V.

Established: 1991 Listing Date: Jun, 1993 Ticker Symbol: KOF Head Office: Reforma 404 Piso 3 - México, D.f. Chairman: Eugenio Garza Lagüera

lndependent Auditor: Ruiz Urquiza y Cía, S.C. Nature of Control: Mexican Prívate No. of Employees: 11,996 References: Bancomer/

Background

173

Coca-Cola FEMSA has its origin in Fomento Económico Mexicano, S.A. de C.V. (its holding company). In 1979, it acquired the control of its subsidiaries which today constitute the Coca­cola FEMSA. lts subsidiaries are engaged in the production, trading adn distribution fo soft drinks in Mexico City, neighboring areas, southeast Mexico (Tabasco state and neighboring areas of Oaxaca, Chiapas and Veracruz states). Coca-Cola FEMSA was establisehd in October, 1991, as part of the FEMSA shareholding reestructuring process, to carry out strategic associations in its businesses. In June, 1993, FEMSA joined its soft drinks business with The Coca-Cola Company, which today owns 30% of Coca-Cola FEMSA capital and in September, 1993, FEMSA placed 19% in Mexico, New York and Europe markets.

Main Officers Director General Dir Fin & Adm

Alfredo Martínez Urda! Héctor Treviño Gutiérrez Rafael Suárez Olaguibel Ernesto Torres Arriaga Hermilo Zuart Ruiz Martín Lara Espíritu Eduardo Ricaurte Quarz Guillermo Pérez Peniche Rosendo Pérez Pinzón Gustavo León Basurto Simon fox

Dir, Oper Valle de Mexico Dir Technical

No. of shares outstanding Serie A Serie D Serie I Total

Main Affiliated & Associated

Dir Administration Dir Souteast Reg Dir, Mktg Dir Projects Dir Hum Res Dir, Devel Dir Systems

Dec 93 242,250,000 142,500,000

90,250,000 475,000,000

Industria Embotelladora de Mexico (99.90%) Embotelladora de Tlalnepantla (99.90%) Distr. de Bebidas Valle de Mexico (99.90%) Embotelladora del Istmo (99.90%) Refrescos de Oaxaca (99.90%)

Business Soft drinks Manuf Soft drinks Manuf Soft drinks Distr Soft drinks Manuf Soft drinks Manuf

174

Main Market & Competition Coca-Cola FEMSA is leader in the markets which trades. During 1993, the share market were: 58.2% of Valle de Mexico against Pepsico and 38.8% in total industry, in the meantime in Southeast region the market share was 71.9% and 60.9% respectively.

Main Raw Materials & Sources The main raw materials are: concentrates, whicha a great part is purchased by Compañía Coca-Cola subsidiary; sugar which is supplied by Promotora Mexicana de Embotelladoras, S.A. de C.V.; water which is extracted by undeground well in accordance to the government permission; as well as bottling and packaging materials, with the majority of them purchased by FEMSA subsidiary. .

GRUPO FINANCIERO BANORTE, S. A. DE C. V.

Authorization Date: Jun 30, 1992 Authorization No: 102-E-366-DGSV-1520 Head Office: Zaragoza, 920 Sur - Edificio Gran Plaza - 64000 - Monterrey N. L. Chairman: Roberto Gonzalez Barrera

No. of Clientes: 214,120 No. of Employees: 4,400 No. of Branches: 150

Background

175

Grupo Financiero Banorte has its origin through a merger between Banco Mercantil del Norte and Afin, Grupo Financiero. From September 20, 1993, it began to execute services of multiple bank, brokerage house, foreign exchange, financia! leasing, factoring and warehousing, providing a high quality total and personalized service to satisfy the clients financia! needs.

Assets Under Management Banco Mercantil del Norte Afin, Casa de Bolsa A fin, Arrendadora A.F., Casa de Cambio Others Total

Main Officers Francisco J. Patiño Leal Francisco Gonzalez Martinez Luis R, Seyffert Velarde Jorge Colin Huerta Alejandro Alvarez Figueroa Gerardo Gomez Alejandro D. Martínez Enrique Catalan G.

No. of shares outstanding Serie A Serie B Serie c Total

US$'000 3,984

359 13 4

4,360

Dir, General Dir. Bank Dir, Fin & Oper Dir, Plann Dir, Bkge House Dir, Leasing Dir, Warehouse Dir, Factoring

Dec 93 144,097,753

52,706,248 65,748,014

262,552,015

Main Affiliated & Associated Business Banco Mercantil del Norte (97.75%) Afin, Casa de Bolsa (100.00%) A.F. Casa de Cambio (100.00%)

Multiple Bank Brokerage House Foreign Exchange

GRUPO CARSO, S. A. DE C. V.

Established: 1980 Listing Date: Jan, 1990 Ticker Symbol: GCARSO

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Head Office: Paseo de las Palmas, 265 Col. Lomas de Chapultepec - 11000 - México, D. F. Chairman: Carlos Slim Helu

lndependent Auditor: Ruíz Urquiza y Cía. S.C . Nature of Control: Mexican Prívate No. of Employees: 40,416 References: Bancomer/New York/Citibank/ Bancomer/Banamex/Sertin

Background The Group was established in October 1980 under the denomination of Grupo Galas, S.A. Afeter several changes and reforms in its by-laws took place along varous years, in May 1990 it changed its denomination to Grupo Carso, S.A. de C.V. and, again, also changed its by-laws. GCARSO is a fullfledged holding, or controlling company and since its inception it has had an ascendent characteristic in the acquisition of companies .

Main Officers Alejandro Escoto Cano Dir. Finance

No. of shares outstanding Serie A Total

Dec 93 915,000,000 915,000,000

Main Affiliated & Associated Business Cigarros la Tabacalera Mexicana (71.06%) Sanborn Hermanos (77.42%) Industrias Nacore (99.54%) Empresas Frisco (95.14%) Grupo Condumex (88.83%)

Tobacco Commercial Steel Production Extracting Holding

GRUPO EMBOTELLADORAS UNIDAS, S.A. DE C.V.

Established: 1986 Listing Date: Sep, 1987 Ticker Symbol: GEUPEC Head Office: Severo Díaz No. 17 Ph 1 - Guadalajara, JAL Chairman: Juan l. Gallardo Thurlow

lndependent Auditor: Hernández Lozano Marrón Lebrija Nature of Control: Mexican Prívate No. of Employees: 3,986 References: Banamex/Mercantil de Mexico/ Banco Mexicano/ Chemical Bank

Background

177

The Company was established as a result of a merger between Grupo Trieme, S.A de C.V. and Grupo Embotelladoras unidas, S.A. de C.V. in 1987. The company has maintained a consistent growth and has been re-investing 100% of its profits which, combined to the modernization project of its plan infrastructures, aims at facing the global market growth for soft drinks through new developments such as the liter and half returnable plastic bottle.

Main Officers Virgilio Pérez Pascoe lldefonso Ochoa Martínez Armando Puente Rincón Gonzalo Guerrero Magaña Joaquín Martínez Yepez Dionisio Pozos Pérez Gerardo Olaguíbel Medrano

No. of shares outstanding A1- A2 81- B2 Total

Main Affiliated & Associated

President V-P, Finance Dir, Fin & Contr Dir, Plant Dir, Plant Dir, Plant Dir, Plant

Dec 93 28,452,668 27,336,877 55,789,545

Embotelladora de Occidente (100.00%) Bebidas Purificadas delCentro (100.00%) Bebidas Purificadas de Michoacan (100.00%) Bebidas Purificadas del Cupartitzio (100.00%)

Main Market & Competition

Business Bottling Bottling Bottling Bottling

The Company's distribution and sales are located in the states of Jalisco, Guanajuato, Michoacan and an area of Colima. Main competitors are the soft drinks bottling of Coca-Cola, Peñafiel and AGA products.

Main Raw Materials & Sources Main raw materials and suppliers are: concentrates - Pepsicola Mexicana, S.A. de C.V.; sugar­Corporativo Azucarero Mexico; glass - Vidriera Guadalajara .

GRUPO FINANCIERO BANCOMER, S. A. DE C. V.

Authorization Date: Jan 27, 1992 Authorization No: 102-E-367-DGBM-111-A-243 Head Office: Av. Universidad 1200 - 03339 - México, D.F. Chairman: Eugenio Garza Lagüera

No. of Clientes: No. of Employees: 37,086 No. of Branches: 983

Background

178

In January, 1992, the Treasury and Public Credit Department authorized Grupo Financiero Monterrey to change its name to Grupo Financiero Bancomer, S.A. de C.V., which was formed by the following institutions: Acciones Bursátiles, S.A. de C.V., (Casa de Bolsa Bancomer). Arrendadora Monterrey, Factor de Capitales, S.A. de C.V. and Bancomer, S.A. In September, 1993, the GFB began to operate its "Nuevo Modelo Estratégico" (New Strategic Model), with the purpose of foreseeing and satisfy the market needs

Main Officers Ricardo Guajardo Touche Carlos Aguilar Villalobos Guillermo Acedo Romero Alfonso Gonzalez Mogoya Francisco Javier Fernandez C Steven Saide Azar Adolfo Lagos Esponosa Juan Carlos Braniff Hierro Víctor Borras Setien Hector Rangel Domene Mario Laborin Gomez

No. of shares outstanding Serie A Serie B Serie c Serie L Total

Main Affiliated & Associated Bancomer (99.98%)

Dir General Dep Dir, Gen Contr Dep Dir, Cred/Risk Control Dep Dir, Fin & Mgt Control Dep Dir, Sys, Plan & Oper Dep Dir, Hum Res & Comm Dep Dir, Gen Cons Bkg Dep Dir, Gen Serv Bkg Dep Dir, Mortgage Bkg Dep Dir, Gen lnstl Bkg Dep Dir, Gen Special Bkg

Dec 93 1,687,680,912

655,097,886 1,034,400,642

916,725,954 4,293,905,394

Business Bank

Casa de Bolsa Bancomer (99.98%) Arrendadora Monterrey (100.00%) Almacenadora Bancomer (63.81 %) Factor de Capitales (100.00%)

Brokerage House Leasing Warehouse Financia! Factoring

GRUPO FINANCIERO INVERMEXICO, S. A. DE C. V.

Established: 1991 Listing Date: May,1993 Ticker Synmbol: GFINVER Head Office: Paseo de la Reforma, 211- piso 17- 06500- México, D.F. Chairman: Carlos Gomez y Gomez

lndependent Auditor: Ruiz, Urquiza y Cia. S.C. Nature of Control: Mexican Prívate No. of Employees: 8,235 No. of Branches: 260 Overseas: New York/London/Cayman lslands

Background

179

On August 23, 1991, S.H.C.P. authorized Grupo Financiero lnvermexico, S.A. de C.V. to be constituted as a finance association in terms of finance association law. lt was established in November, 1991 and has as its main activity to operate as a holding of financing companies which renders services of commercial a·nd investment banking, securities intermediation, leasing, factoring and purchase/sale of foreign exchange. In 1994, the Group acquired an insurance and a security broker and formed a warehouse in association with USCO Distribution lnc. to extend its range of rendering services.

Assets Under Management Banco Mexicano Finance Leasing Total Assets Factoring Total assets Foreign Exchange Total Assets Brokerage House Total Assets Real Estate Total

Main Officers Carlos Gomez y Gomez Manuel Somoza Alonso

13,593,805 443,361 137,862 28,512

6,425,929 2,193

20,631,653

President Dir. General

Enrique Castillo Sanchez Mejorada Jose Manuel Gonzalez Sordo

V-P, Corp Bkg & Branches V-P, Comm Bkg

Juan Marco Gutierrez Wanless Adolfo Perez Borja Siegrist Jose Ignacio de Abiega Pons Antonio Cortina lcaza Guillermo Mascareñas Milmo

No. of shares outstanding Serie A Serie B Serie c Total

Main Affiliated & Associated Banco Mexicano (99.80%) lnvermexico (99.99%)

Dep Dir Gen, Adm & Fin Dept Dir Gen, Mon Mkt, Treas Dep Dir Gen, lntl Dir, Gen Brokerage House Dir, lntl Oper

Dec 93 369,495,380 331,236,293

23,769,071 724,500,744

Business

Arrendadora Financiera lnvermexico(99.99%) lnvermexico Casa de Cambio (99.99%) Factoring lnvermexico (99.99%)

Bank & Credit Securities lntermed Leasing Foreign Exchange Factoring -

GRUPO FINANCIERO SERFIN, S. A. DE C. V.

Established: 1989 Listing Date: Dec, 1993 Ticker Synmbol: GSERFIN Head Office: Insurgentes Sur, 1931- 01020- México, D.F. Chairman: Adrián Sada González ·

lndependent Auditor: Ruiz, Urquiza y Cia. S.C. Nature of Control: Mexican Private No. of Employees: 21,000 No. of Branches: 591 Overseas: New York/Los Angeles/Tokyo/Toronto/Paris/London

Background

180

Grupo Financiero Serfin is one of the three largest financia! groups in Mexico. The power base of the group lies in its wide share ownership base, with over 3,000 shareholders from all over the country which cover diverse economic activities and are represented by over 299 members integrating the regional boards. Grupo Financiero Serfin has adequate resources to develop an efficient and leading universal banking system to satisfy the financia! needs of its clients.

On December 1993 the Group succesfully placed 69 million GFSerfin L Shares in the lnternational Capital Markets and listed its shares on the New York Stock Exchange. This included 11 million ADS's each representing four L shares. This transaction was a first for a Mexican financia! services group and contributed to the Group's financia! consolidation. Of the total offering proceeds, N$ 307 million was applied to the Bank bringing its capitalization ratio above the minimum required level of 8% to 8.9%

NOTE: The following information is derived from financia! statements prepared in accordance with Mexican regulatory principies and does not present financia! positions, results of operations,or other information in accordance with US generally accepted accounting principies. The following information is not intended to present financia! information in accordance with accounting principies generally accepted in the countries of users of financia! statements outside Mexico.

Main Officers Adrian Sada González Abelardo Morales José Ignacio Moreno Carlos Valenzuela Fernando García Cuellar Eduardo García Lecuona Susan Prado OEdmund Belak

No. of shares outstanding "Ali "811 "LII Total

Chairman of the Board C.E.O. C.F.O. Capital Markets & lntl I nternational Financia! Planning lnvestor Relations

Georgeson & Company

Dec 93 209,661,000 191,386,307

97,792, 152 498,839,459

Main Affiliated & Associated Banca Serfin (99.07%) Operadora de Bolsa Serfin (99.93%) Factoraje Serfin (51.99%) Afianzadora Insurgentes (99.99%) Arrendadora Serfin (51.00%) Almacenadora Serfin (51.00%) Seguros Serfin (99.99%)

Business Banking Brokerage House Factoring Bonding Leasing Warehousing lnsurance

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EMPRESAS LA MODERNA, S.A. DE C.V.

Established: 1971 Listing Date: Oct. 1971 Ticker Synmbol: MODERNA Head Office: Av. Franciso l. Madero 2520 Pte- Monterrey, NL Chairman: Alfonso Romo Garza

lndependent Auditor: González Vilchis y Cia., S.C. Nature of Control: Mexican Prívate No. of Employees: 5,620 References: Bancomer/Banca Serfin/Banamex/First National Bank of Boston/Chase Manhattan Bank/Bank of New York

Background

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Cigarrera La Moderna was established in 1936. lt produces and sells more than 29,000 millions of cigarettes. lt is the leader in Mexican Market with a participation of about 56%, and sells two out off three main cigarrette brands: Raleigh and Montana; and exports cigarrettes to several countries of the world. In 1982 it established Aluprint, which supplies several packing materials to Cigarrera La Moderna as well as to other clients users of flexible and folding packing.

Main Markets & Competition The cigarette market is comprised by the adult population of Mexico, and the Company?s main competitor is Cigarros La Tabacalera Mexicana, S.A. de C.V.

Main Raw Materials & Sources Tobacco, packing materials, and acetate wick, ali of which are domestically produced. Main suppliers are: Aluprint, Kimberly Clark, Celanese Mexicana and direct harvesters, in the case of tobacco.

Main Officers Alfonso Romo Garza Francisco Gonzalez Sebastia Eugenio F. Najera Solorzano Eugenio Clemente Solero González Juan Jase Martínez Ramírez Ornar Diaz Maza Osear Javier Velasco Martínez Jose Antonio Casillas Gomez Jase Carlos Trujillo Vazquez Jose Luis Martínez González Raul San Miguel Zamora Jose Manuel García y García Alejandro Rodríguez Graue Carlos Herrera Treviño

Dec 93

Chairman Dir Gen Empr. La Moderna Dir Gen Cig. La Moderna Director, Mfr Director, Fin Director, Comml Director, Comml Dir, Mktg Dir, Hum Rel Dir, Legal Dir, Systems, Plan & Lag Dir, Gen Aluprint Dir, Gen Agroind. Moderna Dir, Gen Bionova

No. of shares outstanding Serie A Total

410,900.000 410,900,498,839,459

Main Affiliated & Associated Cigarrera La Moderna (99.99%) Aluprint (99.99%) Distribuidora Transitsmica (99.99%) Comercializadora Moderna (99.99%) Bionova (99.99%) Agroindustrias Moderna (99.99%)

Business Tobacco Packing Tobacco Consumer Goods Agrobiotechnology Cattle-raising

SEGUROS COMERCIAL AMERICA, S.A. DE C.V.

Established: 1936 Listing Date: Oct. 1936 Ticker Synmbol: SEGCOAM Head Office: Insurgentes Sur no. 3900 - 0-1030 - México, D.F. Chairman: Alfonso Romo Garza

lndependent Auditor: Mancera Hermanos y Cia. Nature of Control: Mexican Private No. of Employees: 3,940 References: Multibanco Comermex/ Banamex / Citibank

Background

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Seguros Comercial America, S.A. de C.V. is a merger of dtwo majar insurers Seguro La Comercial and Seguros Amercia with a combined experience of more than 100 years. Belongs to pulsar international. Currently provides coverage in ali the different insurance segment in the Mexican market, and is the larges insurance company in Mexico.

Main Markets & Competition Largest insurance company in Mexico. lt has a 21 % total prívate market share •.vitl1 a balanced mix in life and property & casualty.

Main Officers Alfonso Romo Garza Adrian Paez Martínez Jorge de la Maza Tellez Antonio Pozzi Pardo Ruben de la Torre Izquierdo Jorge Guajardo Cruz Eduardo García Gaspar Ricardo Vazquez Cervantes Antonio Peña del Bosque Jorge Campa Gallardo

No. of shares outstanding SEGCOAM "A" SEGCOAM "B" Total

Dec 93

Chairman President Exec, V - P Comm Exec, V - P America Exec, V - P Senior, V - P Treasury Senior, V - P Marketing Senior, V - P Hum Res Senior, V - PE. D. P. Senior, V - P Finance

1,530,000,000 1,470,000,000

3,000,000,000

Main Affiliated & Associated Business Servicios Inmobiliarios La Comercial (99.99%) Real Estate

GRUPO SITUR, S.A. DE C.V.

Established: 1989 Listing Date: July, 1991 Ticker Synmbol: SITUR Head Office: Circ. Agustin Yañez 2342 - 3o. piso - Guadalajara, Jal Chairman: Jose Martínez Guitron

lndependent Auditor: Galaz, Gomez Morfin, Chavero, Yamazaki Nature of Control: Mexican Private No. of Employees: 6,389 References: Banamex,/Bancomer/Serfin/Comermex/Midland Bank/Lazard Freres/Kiddek, Peabody/James Capel

Background

184

Situr activities are mainly engaged in the development of integrated resorts, ownership and operation of hotels, urban developments and service companies. Situr is Mexico's principal develper of integrated resorts. These resorts contain high quiality hotels, condominiums, and villas and include a variety of complementar¡ resort facilities such as golf courses, marinas and shipping centers. Situr is also one of the countr¡'s leading hotel owners and operators and seller of timeshare units. situr recently has expanded its development activities to the planning, construction and marketing of residential and commercial developments located primarly in or near urban areas.

Main Markets & Competition lntegrated resorts: personal buyers and secondar¡ developers. Practically no competition. Hotels: direct clients -45%; and trough sales agents -55%. Other hotel chains. Urban developments: personal buyers and secondar¡ developers. Other real estate developers.

Main Raw Materials & Sources lntegrated resorts and urban developments: construction services provided by affiliated and other companies. Hotels food, beverages and operating equipments are provided by severa! suppliers.

Main Officers Jase Martínez Guitron Chairman Kenneth Pr¡sor Jones Dir, General Javier Madrigal Magaña Dir, Corporate & Serv Gabriel Ruiz Huerta Dir, lntegrated Resorts Jose Manuel Gomez Gil Dir Hotels Alberto Leonel de Cervantes G Dir, Urban Devel Francisco Zinser Lopez Dir Hotel Oper Gerardo Ulate Carballo Dir, Planning & D Salvador Andalon García Dir, Administration Guillermo Martínez Conte Dir, Finance

No. of shares outstanding Serie A Serie B Total

Main Affiliated & Associated

Dec 93 365,359,437 351,031,615 716,391,052

Situr Desarrollos Turísticos (99.99%) Sitinvest (99.99%) Siturbe (99.99%) Mega Land, Estratur, Sidektur (each one)(99.99%)

GRUPO SYNKRO, S.A. DE C.V.

Established: 1955 Listing Date: May, 1966 Ticker Synmbol: SYNKRO

Business lntegrated Resorts Hotels Urban Development Services

Head Office: Blvd. Manuel Avila Camacho No 191 - México, D.F. Chairman: Crescencio Ballesteros lbarra

lndependent Auditor: Ruiz Urquiza y Cía. Nature of Control: Mexican Prívate No. of Employees: 5,108 References: Banco Internacional/ Banco Mexicano in Mexico & New York I Probursa in Mexico & New York

Background

185

Grupo Synkro is engaged in the manufacturing and distribution of high quality consumer products with trademark franchising in American markets. the main business is realted to socking, sockpants, hosiery. In the textile field, it participates through the companies: Cannon, Canofil, Arcoplus, Arcoplus Argentina it also participated in the acquisition of Kayser-Roth in the United States. The Group's aim is to consolidate its international leadership position in the hosiery business assuring through globalization process the competitive excelency of worldwide class.

Main Markets & Competition The Group is leader in the hosiery market with 56% of the market; its main competitors are Mallorca 14%, Maquintex 5%, Royalmilch 4%. In the socks market its participation is of 15%, and the nearest competitor is lnterpunto de Mexico. In plastic shoes, it holds 26% of the market and the nearest competitor is Sandak. In insecticide and cosmetics market it ranks third, being the leader in the segments Johnson and Max Factor respectively.

Main Raw Materials & Sources Nylon and Lycra - Akra de Mexico and Celanese Mexicana (domestic and imported), Textiles Kaltex, Telas Especiales de Mexico, Plásticos Pala, Grupo Primex, Resina Polímeros de Mexico.

Crescencio Ballesteros lbarra Jose Luis Ballesteros Franco Javier De la Rosa Lima Alberto Cabal Hermosillo Hector Zires Cataño Tessie Picaza Carlos Cummings lbarra Eduardo Cordero Blanco Antonio Villanueva Esqueda Juan Francisco Plaza Tron

Chairman V-P Exec & Gen Dir Alt Dir, Gen Adm & Fin Dir, Mktg & Plann Dir, Corp & Legal Dir, Public Relations Dir, Gen Textile Div Alt Dir, Gen Textile Div Dir, Gen Shoes Div Dir, Gen Cosm & Home Care Prod

186

No. of shares outstanding Serie A Serie B Serie e Total

Dec 93 42,520,670 40,853,192

8,419,476 91,793,383

Main Affiliated & Associated Industrias Can non Milis (100.00%) Arcoplus (100.00%) Canofil (100.00%) Calzado Puma (100.00%) Grupo Prolar (100.00%)

Business Textil e Textile Textil e Tennis & plastic shoes lnsecticide & cosmetics

187

VALORES DE MONTERREY, S.A. DE C.V.

Established: 1980 Listing Date: Aug, 1985 Ticker Synmbol: VAMSA Head Office: Presidente Masaryk, 8- 11588 México, D.F. Chairman: Eduardo A. Elizondo L.

lndependent Auditor: Mancera S.C. Nature of Control: Mexican Prívate No. of Employees: 2,81 O References: Bancomer I Serfin

Background

188

Valores Monterry started its operations under the denomination of Visa Pesca, and during this year VAMSA merged with Fomento Proa and joined to an American company Aetna lnternational lnc. The company's objectives are to promote, constitute, organize, operate or take participation in the capital of mercantile and commercial companies.

Main Markets & Competition In the insurance market the Company competes mainly with Grupo National Provincial S.A., Comercial Amercia and Segumex; in the surety sector the main competitor is Afianzadora Insurgentes.

Main Officers Federico Reyes García Charles F. Reis Osear Carrillo Chavez

Dir, General Dir, Adm & Fin Dir, Auditing

No. of shares outstanding Serie A Serie B Serie L Total

Dec 93 21,496,126 20,653, 171 10,514, 128 52,663,425

Main Affiliated & Associated Seguros Monterrey Aetna (99.99%) Fianzas Monterrey Aetna (99.99%) Grupo VAMSA (99.99%)

Business lnsurance Surety Corporate Services

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